Asset Market Participation, Monetary Policy Rules, and the Great Inflation

September 1, 2006

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Format: Chicago

Florin Bilbiie, and Roland Straub. Asset Market Participation, Monetary Policy Rules, and the Great Inflation, (USA: International Monetary Fund, 2006) accessed November 9, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

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."

Subject: Consumption, Financial markets, Financial services, Hyperinflation, Inflation, National accounts, Prices, Real interest rates, Securities markets

Keywords: Aggregate demand, Asset holder, Asset market participation, Consumption, Era estimate, Fed policy, Great Inflation, Hyperinflation, Inflation, Interest rate, Limited Asset Market Participation, Monetary policy, Monetary policy rule, Nominal interest rate, Passive Monetary Policy, Phillips curve, Real interest rates, Securities markets, WP

Publication Details

Pages:

34
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2006/200
Stock No:

WPIEA2006200
ISBN:

9781451864601
ISSN:

1018-5941

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