Monetary cooperation during global inflation surges

Abstract

Includes supplementary materials for the online appendix.

We study optimal monetary policy during times of global scarcity of tradable goods. The optimal monetary response entails a surge in inflation, which helps rebalance production toward the tradable sector. While the inflation costs are fully borne domestically, however, the gains in terms of higher supply of tradable goods partly spill over to the rest of the world. National central banks may thus fall into a coordination trap and implement an excessively tight monetary policy causing an unnecessarily sharp global contraction.

Luca Fornaro acknowledges financial support from the European Research Council under the European Union's Horizon 2020 research and innovation program, Starting Grant (851896-KEYNESGROWTH); the Spanish Ministry of Economy and Competitiveness, through the Severo Ochoa Programme for Centres of Excellence in R&D (CEX2019-000915-S); and from the Generalitat de Catalunya, through CERCA and SGR Programme (2017-SGR-1393). Federica Romei acknowledges the financial support from the UK Research and Innovation joint European Research Council Grant (EP/X027228/1).