Ivan Werning
@ivanwerning.bsky.social
MIT Robert M. Solow Professor of Economics | Macro, International, Public, Monetary, Taxes, Finance | v = u + β v | Beatles | Boston | Argentina | Patagonia
Iván Werning is an Argentine economist who has served as the Robert M. Solow Professor of Economics at the Massachusetts Institute of Technology since 2014.
Source: Wikipedia
Economics
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Finally we have our day
That was my feeling too. Has so much potential though. Cleaner. Etc.
Excellent.
Reposted by Joshua Goodman
I have been missing from here. Is this growing or shrinking? Opinions?
Ivan Werning
@ivanwerning.bsky.social
· Sep 6
Here is a video of this presentation on Tariffs and the best monetary policy response:
www.youtube.com/live/DoFrOjJ...
www.youtube.com/live/DoFrOjJ...
Ivan Werning
@ivanwerning.bsky.social
· Jun 9
Final thought...
Optimal Currency Area literature (Mundell) studied when a common currency is not too costly for stabilization.
But if coordination is valuable, our mechanism says a common currency can be strict benefit!
So maybe the Euro was a good idea?... 🤔
Optimal Currency Area literature (Mundell) studied when a common currency is not too costly for stabilization.
But if coordination is valuable, our mechanism says a common currency can be strict benefit!
So maybe the Euro was a good idea?... 🤔
Ivan Werning
@ivanwerning.bsky.social
· Jun 9
Unlike most prior work on issues of coordination...
Our results are not driven by traditional beggar-thy-neighbor (on output, not inflation as here) nor by terms-of-trade-effects (market power, our countries take global price as given).
Our results are not driven by traditional beggar-thy-neighbor (on output, not inflation as here) nor by terms-of-trade-effects (market power, our countries take global price as given).
Ivan Werning
@ivanwerning.bsky.social
· Jun 9
This leads to what we call an expansionary bias.
In response to a negative supply shock (say, an oil shock), decentralized monetary policy is too loose.
Inflation is too high, output too high. Relative to the coordinated optimum.
In response to a negative supply shock (say, an oil shock), decentralized monetary policy is too loose.
Inflation is too high, output too high. Relative to the coordinated optimum.
Ivan Werning
@ivanwerning.bsky.social
· Jun 9
Pictures speak louder than words... (Q is the global input price).
Equilibrium must be on red line: world Phillips curve...
...yet countries think they can deviate along the flatter blue line...
...but all that does is raise the price Q and shift their curve! 😳
Equilibrium must be on red line: world Phillips curve...
...yet countries think they can deviate along the flatter blue line...
...but all that does is raise the price Q and shift their curve! 😳
Ivan Werning
@ivanwerning.bsky.social
· Jun 9
Intuitive step #1: we show world Phillips curve is typically steeper than the individual country's Phillips curve.
Each central bank thinks 💭 “The cost of lowering inflation is too damn high.”
An ideal world planner 💭 “No! Those global supply disruptions are relative!”
Each central bank thinks 💭 “The cost of lowering inflation is too damn high.”
An ideal world planner 💭 “No! Those global supply disruptions are relative!”
Ivan Werning
@ivanwerning.bsky.social
· Jun 9
Thus, we uncover an inflationary externality:
Higher output → higher global input demand → higher global input prices → higher global inflation 😭
No country internalizes this feedback.
Higher output → higher global input demand → higher global input prices → higher global inflation 😭
No country internalizes this feedback.
Ivan Werning
@ivanwerning.bsky.social
· Jun 9
Key mechanism...
1. Each country takes the world input price (that rises!) as given
2. But jointly, they are affecting it!
Result: Countries do not internalize that by tightening more, they could (collectively) lower the supply in the input. Ergo, they don't tighten enough!
6/N
1. Each country takes the world input price (that rises!) as given
2. But jointly, they are affecting it!
Result: Countries do not internalize that by tightening more, they could (collectively) lower the supply in the input. Ergo, they don't tighten enough!
6/N
Ivan Werning
@ivanwerning.bsky.social
· Jun 9
This turns out to be key and imply that well-acting independent central banks can respond in a manner that creates global inflation.
We model a world with...
– Symmetric small open economies
– Wage & price rigidity (both key)
– A global input (e.g. oil) with world price
We model a world with...
– Symmetric small open economies
– Wage & price rigidity (both key)
– A global input (e.g. oil) with world price
Ivan Werning
@ivanwerning.bsky.social
· Jun 9
Our perspective is that this misses a key mechanism that operates during global shocks.
There is little doubt that the recent inflation had two features: it was global in nature (similar across countries), coincided with supply shocks (energy prices, shipping costs etc).
There is little doubt that the recent inflation had two features: it was global in nature (similar across countries), coincided with supply shocks (energy prices, shipping costs etc).
Ivan Werning
@ivanwerning.bsky.social
· Jun 9
This flips the usual narrative. For example, here is Maurice Obstfeld...
"by simultaneously all going in the same direction, they risk reinforcing each other’s policy impacts without taking that feedback loop into account. The highly globalized nature of today’s world economy amplifies the risk."
"by simultaneously all going in the same direction, they risk reinforcing each other’s policy impacts without taking that feedback loop into account. The highly globalized nature of today’s world economy amplifies the risk."
Ivan Werning
@ivanwerning.bsky.social
· May 13
economics.mit.edu
Adding an atlernative non-NBER link in case anyone has trouble with that
economics.mit.edu/sites/defaul...
economics.mit.edu/sites/defaul...
Ivan Werning
@ivanwerning.bsky.social
· May 12
www.nber.org
Hope this adds some clarity to the tariff debates.
Thanks for reading!
Link to paper: www.nber.org/system/files...
Thanks for reading!
Link to paper: www.nber.org/system/files...
Ivan Werning
@ivanwerning.bsky.social
· May 12
Our equivalence result gives a simple way to map these shocks onto classic macro models—and solve them analytically
In the process justifying simple intuitions that serve as guiding lines. It's important to check and ground good intuitions!
In the process justifying simple intuitions that serve as guiding lines. It's important to check and ground good intuitions!
Ivan Werning
@ivanwerning.bsky.social
· May 12
ots of policy commentary says “central banks shouldn’t respond to tariffs.”
That’s not what our model says.
A better rule: Don’t overreact, but don’t ignore either.
Bottom line...
Tariffs create inflation-output tradeoffs that monetary policy can’t ignore.
That’s not what our model says.
A better rule: Don’t overreact, but don’t ignore either.
Bottom line...
Tariffs create inflation-output tradeoffs that monetary policy can’t ignore.
Ivan Werning
@ivanwerning.bsky.social
· May 12
The effects show up in the nominal exchange rate too...
In our setup, tariffs raise prices and depreciate the currency.
This echoes recent empirical patterns during trade tensions.
(capital flight is surely another reason, but basic macro+trade can already explain it)
In our setup, tariffs raise prices and depreciate the currency.
This echoes recent empirical patterns during trade tensions.
(capital flight is surely another reason, but basic macro+trade can already explain it)
Ivan Werning
@ivanwerning.bsky.social
· May 12
A common idea in policy circles is the "see through principle" (not really grounded in economic theory).
It makes some sense as a simple communication device or slogan, but our model says...
... optimal inflation typically exceeds the mechanical pass-through from tariffs.
It makes some sense as a simple communication device or slogan, but our model says...
... optimal inflation typically exceeds the mechanical pass-through from tariffs.
Ivan Werning
@ivanwerning.bsky.social
· May 12
The results hold with sticky wages, but then inflation control is even costlier.
Zero inflation now requires deeper recessions and wage deflation.
The optimal policy is still to accommodate—with some inflation.
Zero inflation now requires deeper recessions and wage deflation.
The optimal policy is still to accommodate—with some inflation.
Ivan Werning
@ivanwerning.bsky.social
· May 12
Here’s what’s NOT optimal...
1. Targeting zero inflation. That would require a sharp contraction in output—too costly.
Letting inflation run a bit helps cushion the blow.
2. "See through principle": hoping inflation rises, but minimally, via direct costs. 9/N
1. Targeting zero inflation. That would require a sharp contraction in output—too costly.
Letting inflation run a bit helps cushion the blow.
2. "See through principle": hoping inflation rises, but minimally, via direct costs. 9/N
Ivan Werning
@ivanwerning.bsky.social
· May 12
Basically, you can do open economy macro with your closed economy model.
Here are some numerical examples run thro the model...
Here are some numerical examples run thro the model...
Ivan Werning
@ivanwerning.bsky.social
· May 12
Technically, our AS IF result is as follows.
-an extra "cost push" epsilon term in the Phillips curve, so it is pushes the curve out.
- the welfare objective is unchanged: dual mandate penalizing inflation and output deviations.
7/N
-an extra "cost push" epsilon term in the Phillips curve, so it is pushes the curve out.
- the welfare objective is unchanged: dual mandate penalizing inflation and output deviations.
7/N
Ivan Werning
@ivanwerning.bsky.social
· May 12
So tariffs are bad, can lead to sharp hit. Optimal monetary policy smooths the adjustment...
Inflation rises in the short run
Output stays above the distorted steady state
Gradual convergence to lower level follows
6/N
Inflation rises in the short run
Output stays above the distorted steady state
Gradual convergence to lower level follows
6/N
Ivan Werning
@ivanwerning.bsky.social
· May 12
It looks something like this using a basic microeconomic intuition. The economy frontier goes down, but also wages are not equal to actual productivity, they are lower, so labor is distorted down. The second effect is stronger starting from free trade.
Ivan Werning
@ivanwerning.bsky.social
· May 12
Intuition: tariffs lower the natural real wage (due to lower profitability) more than productivity. This creates a positive labor wedge, which drives the cost-push effect.
In fact, technically: the productivity loss is second-order, but profitability loss is first order.
In fact, technically: the productivity loss is second-order, but profitability loss is first order.
Ivan Werning
@ivanwerning.bsky.social
· May 12
We analytically characterize the optimal response.
Spoiler: it involves tolerating inflation—temporarily.
It involves softening the blow of tariffs on output and labor.
Intuitively ....
Spoiler: it involves tolerating inflation—temporarily.
It involves softening the blow of tariffs on output and labor.
Intuitively ....
Ivan Werning
@ivanwerning.bsky.social
· May 12
Translation: Tariffs shift the Phillips curve up.
The central bank faces a tradeoff: control inflation or support output.
It can’t do both.
So what should monetary policy do?... 5/N
The central bank faces a tradeoff: control inflation or support output.
It can’t do both.
So what should monetary policy do?... 5/N