Andrea Ferrero (University of Oxford) - Optimal Stabilization Policies in the Wake of Large Shocks

Research seminars

Research Seminar - Andrea Ferrero (University of Oxford) - Optimal Stabilization Policies in the Wake of Large Shocks

Co-authors:  Richard Harrison (Bank of England) and Benjamin Nelson (Balyasny Asset Management L.P.)

Abstract
Motivated by the powerful and multi-dimensional policy response to the Covid-19 pandemic, this paper examines optimal monetary and fiscal policy responses when large shocks force the zero lower bound on the policy rate and a borrowing constraint on the household sector to bind. We characterize optimal targeting rules, showing that a policymaker acting under discretion minimizes social losses characterized by an inflation gap, an output gap, and a gap between the consumption of constrained and unconstrained agents. The borrowing constraint binds occasionally and asymmetrically, implying a role for optimally targeted fiscal measures, such as large tax cuts or transfer payments, when constrained agents' consumption falls inefficiently low. We examine optimal policies in a stylized quantitative simulation of macroeconomic dynamics in the United States over the 2020-22 period.

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