Working Paper

Monetary Policy and the Great COVID-19 Price Level Shock

Abstract: We use an analytically tractable DSGE model to study the surge in the cost of living in the wake of the COVID-19 pandemic. A calibrated version of the model is used to assess the conduct of US monetary and fiscal policy over the 2020-2024 period. The model is also used to estimate the economic and welfare consequences of alternative monetary and fiscal policies. The calibrated model suggests that while the extraordinary fiscal transfers made in 2020-21 generally improved economic welfare, they were significantly larger than needed. These welfare gains came primarily in the form of insurance, not stimulus. For the observed fiscal policy, an optimal monetary policy would not have resulted in a significantly different inflation dynamic. Although monetary policy could have prevented the inflation surge with sufficient fiscal support, such a policy would have required a permanently higher real rate of interest and a permanent recession. Finally, our model suggests that while observed monetary policy muted the inflation dynamic, it did not significantly alter the total amount of inflation experienced. Finally, the COVID-19 inflation would have been mean-reverting even without an aggressive tightening of monetary policy.

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

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

Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2025-02-14

Number: 2025-004