Disagreement matters: New evidence on the state-dependent effects of monetary policy
Variation in disagreement about inflation expectations is a well-known stylized fact in survey data, but little is known how disagreement interacts with the transmission of monetary policy shocks. This paper fills this gap in providing theoretical model predictions for different levels of disagreement and testing these empirically. When disagreement in high, a New Keynesian dispersed information model predicts that a contractionary monetary policy shock can lead to a short-run rise in inflation and inflation expectations and a strong output decline. We test the theoretical state-dependent predictions by estimating a smooth transition local projection model on U.S. data. In doing so this paper makes three contributions: (i) we provide external validation of dispersed information models, (ii) we document large differences in the inflation (expectations) response between the low and high-disagreement regime, and (iii) when disagreement is high, inflation and inflation expectations increase by up to 0.9 pp after a contractionary monetary policy shock, while output declines.