Are negative supply shocks expansionary at the zero lower bound?

In a new paper, Johannes Wieland reports (pdf):

 Standard sticky-price models predict that temporary, negative supply shocks are expansionary at the zero lower bound (ZLB) because they raise inflation expectations and lower expected real interest rates, which stimulates consumption. This paper tests that prediction with oil supply shocks, an earthquake, and inflation risk premia, demonstrating that negative supply shocks are contractionary at the ZLB despite also lowering expected real interest rates. These findings are rationalized in a model with financial frictions, where negative supply shocks reduce asset prices and net worth, translating into larger borrowing spreads so that consumption contracts. In this data-consistent model fiscal stimulus at the ZLB is substantially less effective than in standard sticky-price models.

This accords both with common sense and recent experience.

For the pointer I thank Karl Smith.


The main problem here is that the choice of modelling "government spending", through increased marginal costs being the main driver towards increased inflation expectations, is completely implausible to begin with. Cynically, the only reason for its existence is because Certain Unnamed Prominent New Keynesians want to provide a unified model to defend both temporary fiscal stimulus and certain policies that temporarily increase marginal costs in response to recessions. There is flatly no reason for this to be the case. The core intuition - that shocks to labour wages would add even more uncertainty at a time when the macroeconomic price mechanism is already choking on adjustment problems - demands a financial frictions mechanic, not expectations channel.

Proposal: macro-economists are not allowed to use any models, anymore, anytime, for any purpose. They are also not allowed to use econometric "studies". Get into a room and argue about policy based on whatever opinions you have. Use of some comparative economic history is OK. Come to grips with the fact that you are all biased political scientists playing with matches.

Proposal: CPV is not allowed to use a computer, anytime, for any purpose, because he is an idiot.

In case anyone is interested, John Cochrane posted a rather in depth discussion of this paper:

Bah, I am slowly giving up on any and all NK models. Of course I had also long ago gave up on RBC models.

I now believe the entire concept of general equilibrium in an economy is ridiculously simplified. Once upon a time these models gave simple general rules that explain very large structures. As they get more complicated the assumptions required so that a model is solvable ruins any utility.

This is just post-hoc theorizing with fancy looking math.

"Are negative supply shocks expansionary at the zero lower bound?"

Translation: Can an owner of commodities raise prices by destroying supplies? Can this be done when the rate of interest is zero?

Answer. Yes. Farmers have been doing it for centuries, when they didn't think they were getting a fair price for their wheat, milk, etc. Wall St. banks are the only ones who get to pay zero interest for borrowing from the government. For them the supply of money never experiences a "negative shock." That only happens to those who work for a living.

More evidence that sticky price models are nonsense.

I don't know if anyone else is still interested in this post, but I'm still working on it. The problem is that the Wieland Paper is tough on it's own, and I find that I have to read a number of his secondary sources to see why he's claiming what he claims. These secondary sources are tough too. Added to that, I'm not sure I find the NK Position useful. Added to that, the secondary sources sometime seem to argue against Wieland. Added to that, some I can't get to. However, one issue seems clear to me, so I want to split it out.

I'm not sure that the Japanese Earthquake of 2011 works as an example. In my view, the Government Borrowing/Spending Money is what triggers Inflation Expectations. Raising Taxes, for example, would be Contractionary, in my view. However, the Japanese did something equivalent.
They Cut Salaries where it was easy to do so, as opposed to the harder choice of raising taxes. How this effects the NK Model I'm not sure, but it surely effects mine.

Would Katrina be a Supply Shock?

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I don't really understand the paper but I love this from the abstraction:

"These findings are rationalized in a model"

Refreshingly honest :)

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