Asset-market participation, monetary policy rules, and the great inflation, Issues 2006-2200
International Monetary Fund, 2006 - Business & Economics - 33 pages
This paper argues that limited asset market participation is crucial in explaining U.S. macroeconomic performance and monetary policy before the 1980s, and their changes thereafter. We develop an otherwise standard sticky-price dynamic stochastic general equilibrium model, which implies that at low asset-market participation rates, the interest rate elasticity of output (the slope of the IS curve) becomes positive - that is, "non-Keynesian." Remarkably, in that case, a passive monetary policy rule ensures equilibrium determinacy and maximizes welfare. Consequently, we argue that the policy of the Federal Reserve System in the pre-Volcker era, often associated with a passive monetary policy rule, was closer to optimal than conventional wisdom suggests and may thus have remained unchanged at a fundamental level thereafter. We provide institutional and empirical evidence for our hypothesis, in the latter case using Bayesian estimation techniques, and show that our model is able to explain most features of the "Great Inflation."
What people are saying - Write a review
We haven't found any reviews in the usual places.
Other editions - View all
agents aggregate demand argue asset holders asset market participation Beta beta distribution Bilbiie change in asset change in asset-market changes sign coefficient consumption of asset cost-push shocks counterfactual cs,t current income dc/dy degree of asset distribution with mean dynamics elasticity Euler equation expected inflation explain federal funds rate framework fundamental shocks gamma distribution habit persistence income effect increase inflation and output institutional evidence interest rate rules interest rate smoothing IS-curve Keynesian limited asset market macroeconomic macroeconomic variability marginal cost marginal propensity market interest rate monetary policy rule negative income effect nominal interest rate non-asset holders non-Keynesian optimal policy output gap participation in asset passive to active Phillips curve pre-Volcker period price indexation prior propensity to consume real interest rate real rate real wage reduced-form share of non-asset shock processes standard deviation stochastic environment stylized facts sunspot shocks Taylor rule theoretical theories U.S. economy Volcker-Greenspan period Volcker-Greenspan sample Woodford