Monetary Policy Under Okun’s Hypothesis / Felipe Alves, Giovanni L. Violante.

Format:

Book

Author/Creator:

Alves, Felipe.

Contributor:

Violante, Giovanni L.

National Bureau of Economic Research.

Series:

Working Paper Series (National Bureau of Economic Research) no. w33488.

NBER working paper series no. w33488

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2025.

Summary:

The current monetary policy framework of the Fed intends to be more 'inclusive' by running the economy hot for longer during expansions. The logic of this strategy rests on Okun's (1973) hypothesis that sustaining a 'high-pressure economy' persistently improves labor market outcomes of low-wage workers. To evaluate this conjecture, we develop a Heterogeneous Agent New Keynesian framework with a three-state frictional model of the labor market where low-skilled workers are more exposed to the business cycle and recessions have a long-lasting effect on their labor force participation and earnings, in line with the evidence. Under a canonical Inflation Targeting rule, the ZLB generates a deflationary bias and severely amplifies the persistent scars of recessions at the bottom of the wage distribution. The Lower-for-Longer strategy is an effective antidote to the ZLB-driven hysteresis and leads to notable earnings gains for low-wage workers and a reduction to overall earnings inequality. If pursued aggressively, however, the policy reverts the inflation bias from negative to positive. Since policymakers might prioritize differently inflation relative to inclusion, we conclude by quantifying the inflation-inclusion trade-off implied by various monetary policy rules.

Notes:

February 2025.

Print version record