Mark Gertler | Macro Paper Warehouse

Oil Prices, Monetary Policy and Inflation Surges

Thu, 01 Jan 2026 00:00:00 +0000

Gagliardone and Gertler ask why the US inflation surge that began in mid-2021 was both sudden and persistent, and whether a simple structural model can account for it without targeting inflation in estimation. The paper’s central claim is that the surge was driven primarily by the combination of large oil price shocks and accommodative (“easy”) monetary policy by the Federal Reserve, with oil complementarities and real wage rigidity as the key amplification mechanisms. Secondary factors — demand shocks and labor-market tightening — matter but do not drive the surge on their own.

Anatomy of the Phillips Curve: Micro Evidence and Macro Implications

Research Question

This paper addresses a fundamental puzzle in macroeconomics: why do estimates of the New Keynesian Phillips curve (NKPC) slope differ sharply depending on whether real marginal cost or the output gap is used as the real activity variable? The conventional, output gap-based NKPC yields very flat slope estimates (e.g., 0.006 to 0.024 in Hazell et al. 2022 and Rotemberg and Woodford 1997), which has led to the widespread view that the Phillips curve is “flat,” at least during the pre-pandemic period. The authors argue that this view conflates two distinct structural relationships: the elasticity of inflation with respect to real marginal cost, and the elasticity of marginal cost with respect to the output gap.

Chapter 21 The financial accelerator in a quantitative business cycle framework

This Handbook of Macroeconomics chapter develops a dynamic general equilibrium model – since widely known simply as “BGG” – that embeds a credit-market friction into an otherwise standard New Keynesian business-cycle framework in order to formalize and quantify the “financial accelerator”: the idea that endogenous developments in credit markets amplify and propagate, rather than merely reflect, shocks to the macroeconomy. The mechanism rests on a costly-state-verification (Townsend 1979) debt contract between risk-neutral entrepreneurs and financial intermediaries, in which lenders must pay an auditing cost to observe a borrower’s realized, privately known idiosyncratic return; this generates an external finance premium – the wedge between the cost of external and internal funds – that depends inversely on the borrower’s net worth relative to the capital being financed, since low-net-worth borrowers pose greater default risk and hence greater expected agency (monitoring) costs. Because net worth in the model is itself procyclical (rising with profits and asset prices in expansions), the external finance premium is countercyclical, so a positive shock raises net worth, lowers the finance premium, and further stimulates investment and asset prices, which raises net worth again – a feedback the authors formalize in the key relation QK = Ψ(s)N linking a firm’s capital expenditure to its net worth via a premium-dependent multiplier Ψ. Embedding this contracting problem in a Calvo-style sticky-price New Keynesian model with money and, in extensions, one-period investment decision lags and heterogeneous firms with differential credit access, the calibrated model shows the financial accelerator delivers economically large amplification and propagation: in response to an unanticipated 25-basis-point cut in the nominal interest rate, the initial output response is about 50% larger and the investment response nearly twice as large with the accelerator present than in an otherwise identical baseline with the finance premium held fixed at its steady-state level, and the real effects are far more persistent (output and investment four quarters after the shock, with the accelerator, are roughly where they stand after only two quarters without it); the external finance premium itself falls sharply and only slowly reverts to trend, consistent with the paper’s own VAR evidence that credit-spread variables rise ahead of the downturn following a contractionary policy shock. In the two-sector extension with heterogeneous credit access, investment by the more credit-constrained sector rises by nearly three times as much as investment by the better-credit-access sector after an expansionary shock, an “excess sensitivity” result the authors relate to net worth being endogenous in their model, in contrast to models such as Fisher (1996) in which borrowers’ equity positions are exogenously fixed.

Inside the Black Box: The Credit Channel of Monetary Policy Transmission

This 1995 Journal of Economic Perspectives paper by Ben Bernanke and Mark Gertler surveys the “credit channel” of monetary policy transmission — described explicitly as an amplifying mechanism, not an independent channel — under which monetary tightening raises the external finance premium (the wedge between the cost of external and internal funds) on top of its direct effect on market interest rates, thereby explaining three empirical puzzles that conventional interest-rate theory leaves unresolved: the large real effects of small interest-rate movements, the delayed timing of investment and inventory responses relative to the largely transitory rise in rates, and the unexpectedly large and rapid response of residential investment relative to business structures. Using a monthly four-variable recursive VAR (1965-1993), the authors document that after a monetary tightening, real GDP begins declining about four months later and bottoms out around two years out, even though the federal funds rate itself is back near trend within 9-12 months; inventory disinvestment accounts for a substantial part of the initial output decline, and business fixed investment (concentrated in equipment, not structures) responds with the longest lag of all spending components. The paper attributes these facts to two credit-channel mechanisms — a balance sheet (net worth) channel, under which rising rates and falling asset prices directly and cumulatively weaken borrowers’ balance sheets (evidenced by a coverage ratio that tracks the funds rate closely and by roughly 40% of the short-run profit decline coming from higher interest payments), and a bank lending channel, under which reserve drains restrict loan supply to bank-dependent borrowers (evidenced by widening CD-Treasury bill spreads during tight-money periods) — while candidly noting the two mechanisms cannot be cleanly separated empirically and that the bank lending channel has likely weakened since financial deregulation.

Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory*

Estimating a forward-looking Federal Reserve policy rule separately for 1960-79 and 1979-96, this paper finds that the Fed let real short-term rates fall as expected inflation rose before Volcker, but raised real rates more than one-for-one with expected inflation under Volcker and Greenspan. The rule takes the Federal Funds rate target as a linear function of the gap between expected future inflation and a target, plus the expected output gap, nests Taylor’s (1993) backward-looking rule as a special case, and is estimated by GMM on quarterly U.S. data from 1960:1-1996:4. The inflation-response coefficient is estimated at 0.83 (s.e. 0.07) pre-Volcker and 2.15 (s.e. 0.40) under Volcker-Greenspan – a difference the authors show is robust to alternative inflation and output-gap measures, alternative target horizons, subsample splits by Fed chairman, and a backward-looking specification. They argue this shift, not oil shocks alone, is central to the change in macroeconomic behavior: the timing of the 1970s inflation build-up predates the first oil shock, and multivariate evidence suggests oil shocks account for only a modest share of output and inflation variation over the period. Embedding the estimated rules in a standard New Keynesian sticky-price model, the authors show that an inflation-response coefficient below one (as estimated pre-Volcker) admits self-fulfilling, sunspot-driven swings in inflation and output with no fundamental shocks at all, while a coefficient above one (as estimated post-1979) rules this out; even short of formal indeterminacy, a near-unity coefficient substantially amplifies the economy’s response to ordinary supply and demand shocks relative to a coefficient well above one. The paper explicitly leaves open why the Fed followed the inferior pre-Volcker rule for so long, offering only speculative explanations (misperceived potential output, an immature understanding of inflation dynamics).

Monetary Policy Surprises, Credit Costs, and Economic Activity

This 2015 American Economic Journal: Macroeconomics paper by Mark Gertler and Peter Karadi uses a “proxy SVAR” — a structural VAR identified with external instruments rather than timing restrictions — to show that modest, high-frequency-identified surprises in monetary policy produce disproportionately large movements in private credit costs, driven mainly by term premia and credit spreads rather than by revisions in the expected path of short-term rates. Using surprises in federal funds and Eurodollar futures around FOMC announcements (1991-2012) as instruments for a monthly VAR (1979-2012) in which the one-year government bond rate serves as the policy indicator, the authors find that a monetary tightening that raises the one-year rate by about 20 basis points produces a roughly 15 basis-point increase in corporate bond rates and a roughly 7 basis-point increase in mortgage rates, an 8 basis-point rise in the Gilchrist-Zakrajšek excess bond premium persisting for about eight months, and a significant, fairly rapid decline in industrial production reaching its trough after about 18 months — while the response of the CPI is not statistically significant and virtually all the effect on real activity operates through real rather than nominal rates. Decomposing the response of longer-term rates, the paper finds that for two-, five-, and ten-year maturities “virtually all” of the rate increase is due to the term premium rather than the expected path of short rates, and that credit spreads and term premia together (the “excess premium”) account for essentially the entire increase in private borrowing costs — a pattern the authors argue is inconsistent with the standard frictionless monetary transmission mechanism and instead consistent with a credit channel operating alongside limited participation or limits to arbitrage in longer-term bond markets. A key auxiliary finding is that forward guidance matters: substituting the federal funds rate for the one-year rate as the policy indicator, normalized to the same funds-rate movement, produces an output contraction “more than 50 percent smaller,” indicating that surprises which revise expectations about the future path of policy have substantially stronger real and financial effects than surprises confined to the current policy rate.

Monetary Policy, Business Cycles, and the Behavior of Small Manufacturing Firms

This 1994 Quarterly Journal of Economics paper by Mark Gertler and Simon Gilchrist asks whether small manufacturing firms bear a disproportionate share of the manufacturing decline that follows monetary tightening, and whether that disproportion reflects financial frictions (a balance-sheet channel and a bank-lending/credit channel) rather than nonfinancial differences such as industry composition or technological flexibility. Using quarterly, size-class-disaggregated U.S. manufacturing data from the Census Bureau’s Quarterly Financial Report (QFR), 1960:1-1991:4, with “small” firms defined as roughly the bottom 30 percent of sales at each date (a weighted blend of two nominal asset classes straddling that cutoff, adjusted for firms drifting across nominal classes over time), the authors proceed in three stages: descriptive plots of smoothed growth rates and log deviations around Romer-Romer narrative tight-money dates; reduced-form bivariate and multivariate (adding real GNP growth, inflation, and the federal funds rate) VARs estimated by SUR across size classes, with F- and t-tests for the significance and cross-size-class difference of the Romer-dummy coefficients; and structural GMM estimation of an inventory-adjustment (Euler-type) equation augmented with a balance-sheet proxy, the “coverage ratio” (cash flow relative to the short-term interest burden on short-term debt). The reduced-form results show Romer dates strongly and significantly predict declines in sales, inventories, and short-term debt for small firms but have no significant marginal predictive power for large firms; quantitatively, small firms account for an estimated 55 to 60 percent of the drop in total manufacturing sales four, eight, and twelve quarters after a Romer episode despite being by construction only about 30 percent of total sales, and large firms actually accumulate inventories (apparently borrowing to smooth production) while small firms shed them sharply, dragging total manufacturing inventories negative by twelve quarters out. The federal-funds-rate effect on small firms is also asymmetric across the business cycle: the coefficients switch significantly between high- and low-GNP-growth states for small-firm sales (p=0.03) and inventories (p=0.01), but show no significant switching for large firms, and the effect is concentrated in low-growth (recessionary) states. In the structural GMM equations the lagged coverage ratio enters significantly for small firms (coefficient around 1.4 to 1.8 depending on specification) but is insignificant and wrong-signed for large firms (-0.70), and its estimated effect on small firms roughly doubles moving from a high- to a low-growth state (1.21 versus 2.36), though the authors note this cyclical asymmetry is significant only at the 20 percent level; a one-standard-deviation fall in the coverage ratio is estimated to reduce small firms’ annual inventory growth rate by roughly 2.25 percentage points, against an annual inventory growth standard deviation of about 8 percent for small firms. The authors interpret the overall pattern as consistent with both a balance-sheet channel (weaker net worth and cash flow tighten the terms of external finance for small, informationally opaque firms) and a bank-lending/credit channel (small firms rely almost exclusively on bank loans for short-term debt, while large firms can substitute into commercial paper when banks contract lending), and offer evidence against purely nonfinancial explanations — stable durable-goods sales shares across size classes, the cyclical asymmetry itself, and no evidence that large firms subcontract output to small firms in downturns — while acknowledging that firm size is only a correlate of the underlying differences in capital-market access and that aggregate, size-class-level QFR data cannot fully rule out every nonfinancial alternative.

Temporary Layoffs, Loss-of-Recall, and Cyclical Unemployment Dynamics

This paper measures and models the role of temporary layoffs (TL) in cyclical unemployment dynamics, motivating the analysis by the extraordinary surge in temporary layoffs at the onset of the pandemic recession — roughly 15% of employed workers moved to temporary-layoff status from March to April 2020. The paper documents two opposing effects of temporary layoffs on total unemployment: a stabilizing direct effect (workers on TL return to employment rapidly via recall) and a destabilizing indirect effect through “loss-of-recall” — workers initially on temporary layoff who fail to be recalled and instead transition to jobless unemployment (JL), inheriting that state’s far lower reemployment probability. A new recursive accumulation method is used to construct a time series of the stock of workers in jobless unemployment whose most recent exit from employment was to temporary-layoff status (JL-from-TL); this stock has a standard deviation 16 times that of GDP and 2 times that of total unemployment, and is a high-correlation indicator of labor market slack. A search-and-matching model with staggered Nash wage bargaining, endogenous layoff thresholds, and separate recall and new-hire channels replicates the pre-pandemic cyclical behavior of TL and JL flows. Applying the model to the pandemic recession, the paper finds that the Paycheck Protection Program (PPP) reduced employment shortfalls by roughly 2 percentage points at peak, primarily by dampening loss-of-recall — the program’s forgivable loan structure reduced firms’ incentive to permanently separate workers who had been placed on temporary layoff.

The Science of Monetary Policy: A New Keynesian Perspective

This widely cited survey derives monetary policy design from a simple forward-looking New Keynesian model built from first principles – a forward-looking IS-type output-gap equation and a forward-looking Phillips curve – and states its conclusions as a numbered sequence of general “Results” meant to be robust across a wide variety of macroeconomic frameworks. Under discretion (no commitment), optimal policy embeds implicit inflation targeting: the central bank should adjust the nominal rate more than one-for-one with expected future inflation (Result 3, later known as the Taylor principle), should perfectly offset demand shocks but let the nominal rate stay put in the face of shocks to potential output (Result 4), and, more generally, should raise real rates whenever inflation is forecast above target and let it return only gradually. Under commitment, the paper derives a genuinely new result: even when the central bank has no temptation to push output above its natural level (ruling out the traditional Kydland-Prescott/Barro-Gordon inflationary-bias motive for commitment), a credible commitment to a rule still improves the current output-inflation trade-off, because current inflation depends on expectations of future policy, and a rational private sector will discount an un-committed promise of future toughness (Result 7). The paper also formalizes Alan Blinder’s “opportunistic” approach to disinflation as optimal when policy-makers weight small output deviations more heavily than small inflation deviations, showing it is equivalent to targeting inflation within a zone rather than at a point (Result 12), and works through practical complications including imperfect information, interest-rate smoothing, and model uncertainty. Turning from theory to practice, the paper applies its “Taylor principle” criterion to U.S. monetary history, arguing pre-Volcker policy “tended to accommodate rather than fight increases in expected inflation” while Volcker-Greenspan policy adopted the kind of implicit inflation targeting the theory recommends, and closes with simple rules (including Taylor’s and the authors’ own forward-looking variant) and open questions for future research, including endogenous inflation persistence, open-economy extensions, and the zero lower bound.