Structural Changes in Investment and the Waning Power of Monetary Policy

We argue that secular change in both the production and composition of investment goods has weakened investment’s role in the transmission of monetary policy to labor earnings and consumption. We show analytically that fluctuations in the production of investment goods amplify the response of consumption to monetary policy shocks by varying labor income for hand-to-mouth agents. We document three secular changes weakening this channel: (i) labor’s share of value added in investment goods production has declined, (ii) the import share of investment goods has risen, and (iii) the composition of investment has shifted towards components that are less responsive to monetary policy. A small open economy, two agent New Keynesian model calibrated to match these facts implies a 23 percent weaker response of labor income and a 17 percent weaker response of consumption to real interest rate shocks in a 2020s economy relative to a 1960s economy.