Limited Asset Market Participation and Monetary Policy in a Small Open Economy

Paul Levine (), Stephen McKnight, Alexander Mihailov () and Jonathan Swarbrick

No 921, School of Economics Discussion Papers from School of Economics, University of Surrey

Abstract: Limited asset market participation (LAMP) and trade openness are crucial features that characterize all real-world economies. We study equilibrium determinacy and optimal monetary policy in a model of a small open economy with LAMP. With low enough participation in asset markets, the conventional wisdom concerning the stabilizing benefits of policy inertia can be overturned irrespective of the constraint of a zero lower bound on the nominal interest rate. In contrast to recent studies, in LAMP economies trade openness can play an important stabilizing role. We also show that the central bank must balance the opposing influence of openness and LAMP on the aggressiveness of optimal policy, and that the equivalence between efficient and equitable optimal allocation found in closed economies breaks down in open economies. We derive targeting rules and demonstrate the superiority of commitment over discretion in implementable optimal interest rate rules.

JEL-codes: E31 E44 E52 E58 E63 F41 (search for similar items in EconPapers)
Pages: 86 pages
Date: 2021-10
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mac, nep-mon and nep-opm
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https://repec.som.surrey.ac.uk/2021/DP09-21.pdf (application/pdf)

Related works:
Journal Article: Limited asset market participation and monetary policy in a small open economy (2025)
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Persistent link: https://EconPapers.repec.org/RePEc:sur:surrec:0921

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