Monetary Policy in Disaster-Prone Developing Countries

By Chris Papageorgiou, Giovanni Melina, Alessandro Cantelmo and Nikos Fatouros

http://d.repec.org/n?u=RePEc:imf:imfwpa:2022/067&r=dge

This paper analyzes monetary policy regimes in emerging and developing economies where climate-related natural disasters are major macroeconomic shocks. A narrative analysis of IMF reports published around the occurrence of natural disasters documents their impact on important macroeconomic variables and monetary policy responses. While countries with at least some degree of monetary policy independence typically react by tightening the monetary policy stance, in a sizable number of cases monetary policy was accommodated. Given the lack of consensus on best practices in these circumstances, a small-open-economy New-Keynesian model with disaster shocks is leveraged to evaluate welfare under alternative monetary policy rules. Results suggest that responding to inflation while allowing temporary deviations from its target is the welfare maximizing policy. Alternative regimes such as strict inflation targeting, exchange rate pegs, or Taylor rules explicitly responding to economic activity or the exchange rate would be welfare-detrimental. With climate change projected to expand the list of disaster-prone countries, these findings are likely to be soon relevant also for richer or larger economies.

I wonder why this analysis would be limited to emerging and developing economies. Developed economies also suffer major shocks. Covid-19 was in many ways like a natural disaster shock (sudden unavailability of staff, supply disruptions, liquidity needs) leading to major price changes.

Dynamic spatial general equilibrium

By Benny Kleinman, Ernest Liu and Stephen Redding

http://d.repec.org/n?u=RePEc:ehl:lserod:113917&r=dge

We develop a dynamic spatial general equilibrium model with forward-looking investment and migration decisions. We characterize analytically the transition path of the spatial distribution of economic activity in response to shocks. We apply our framework to the re-allocation of US economic activity from the Rust Belt to the Sun Belt from 1965-2015. We find slow convergence to steady-state, with US states closer to steady-state at the end of our sample period than at its beginning. We find substantial heterogeneity in the effects of local shocks, which depend on capital and labor dynamics, and the spatial and sectoral incidence of these shocks.

Many moons ago I tried to develop a spacial dynamic general equilibrium to study the diffusion of inflation, and the considerable lag from shock to inflation change. I got hopelessly lost in the complexities. I am glad to see that this kind of work looks feasible now.

Liquidity constraints and fiscal multipliers

By Diogo Sá

http://d.repec.org/n?u=RePEc:pra:mprapa:112132&r=dge

Although recent studies identified the percentage of constrained agents as the crucial force driving many fiscal policy mechanisms, the values attained were purely the result of model calibrations. We make use of household-level data to estimate the fraction of hand-to-mouth households for several European countries. We calibrate an overlapping generations model with heterogeneous agents to match the net liquid wealth distribution and study the impact of credit constraints on the effectiveness of fiscal consolidation policies. Our findings suggest that the share of hand-to-mouth agents is no longer quantitatively relevant to explain the cross-country heterogeneity in fiscal multipliers when we calibrate the model to match empirically plausible estimates of that share. These results may be driven by the characteristics of the model we employ, which excludes the wealthy hand-to-mouth.

I am intrigued by this result that the proportion of hand-to-mouth households does not matter, at least within the empirically relevant range (20-37%). Indeed, the recent literature has been insisting so much on this feature of household data.