Nonlinear Monetary Policy Tradeoffs

• Authors: Mario Forni, Luca Sala, Luca Gambetti and Davide Debortoli
• BSE Working Paper: 1404 | September 23
• Keywords: monetary policy , structural VAR models , inflation-unemployment tradeoff , proxy- SVAR.
• JEL codes: C32, E32

We measure the inflation-unemployment tradeoff associated with monetary easing and tightening, during booms and recessions, using a novel nonlinear Proxy-SVAR approach. We find evidence of significant nonlinearities for the U.S. economy (1973:M1 – 2019:M6): stimulating economic activity during recessions is associated with minimal costs in terms of inflation, and reducing inflation during booms delivers small costs in terms of unemployment. These results can be rationalized by a simple model with downward nominal wage rigidities, which is also used to assess the validity of our empirical approach.