We believe this work can inform policymaking at central banks around the world, including at @federalreserve.bsky.social @ecb.europa.eu @bankofengland.bsky.social

Key results: when other tools are costly, optimal interest policy tightening should be less aggressive in the presence of financial fragility. If other tools were not costly, the right combination of tools could perfectly separate financial from price stability objectives.

We use the model to characterize the constrained efficient use of interest rate policy, credit policy, equity injection, macroprudential policy and deposit insurance during periods of supply-driven inflation and fragility.

We develop a tractable model in which intermediaries face occasionally binding leverage constraints and endogenous risks of runs, while producers face price adjustment frictions. Interest rate tightening, by lowering asset prices, exacerbates both financial distortions.

Recent events have reignited concerns about the financial stability implications of monetary policy.

Empirically, we show that monetary tightening exacerbates financial stress after supply shocks, through declines in asset prices, bank equity and increased run risks.

Recently, Yang Liu and I revived TIP and uncovered new properties: there is a divine coincidence in times of cost-push shocks; TIP complements (not substitutes) monetary policy; TIP doesn't distort prices (contrary to price controls!). Check it out:
👉 damiencapelle.com/wp-content/u...

a worker belonging to an employee group whose earnings increased by less than 7% in a year would receive a tax-credit proportional to the difference between the realized inflation rate and 7%!

In the real world, the #Carter admin proposed in 1978 a version of TIP ("real wage insurance") to supplement the wage-price guidelines which included voluntary limits on nominal wage and price increases. It gave incentives to workers to enforce the guidelines 👌:

This proposal started a fascinating literature on TIP. Two fun examples: a paper by Laurence Seidman showing how TIP can decrease the NAIRU jstor.org/stable/pdf/253… and one by Abba Lerner proposing a market for wage increase permits brookings.edu/wp-content/upl .

The idea was first proposed by Wallich and Weintraub in 1971: their tax on wage increases (called TIP for Tax-based Incomes Policies) would be levied on wage increases in excess of a pre-announced target and it would be paid by employers.
👉 www.jstor.org/stable/4224073