Monetary Policy and the Great COVID-19 Price Level Shock

Andolfatto, David; Martin, Fernando M.

doi:10.20955/wp.2025.004

Working Paper Revision

Monetary Policy and the Great COVID-19 Price Level Shock

Abstract: We employ a small-scale dynamic general equilibrium model to analyze the surge in inflation following the COVID-19 pandemic. A calibrated version of the model is used to assess U.S. monetary and fiscal policy over the 2020–2024 period and to estimate the economic and welfare consequences of alternative policy scenarios. The analysis suggests that the large fiscal transfers of 2020–2021 were broadly welfare-improving, albeit larger than necessary. Given the fiscal stance in place, optimal monetary policy would not have generated a materially different price level dynamic. While monetary policy could, in theory, have prevented the inflation surge through coordinated fiscal adjustment, this would have required a permanently higher real interest rate and a prolonged recession. The model estimates that observed monetary policy actions helped to moderate the inflation path but had only a limited effect on the cumulative increase in the price level. A fiscal anchor on inflation expectations implies that the COVID-19 era inflation episode would likely have been mean-reverting even without aggressive monetary tightening.

JEL Classification: E40; E52; E60; E63; E65;

https://doi.org/10.20955/wp.2025.004