Limited Asset Markets Participation, Monetary Policy and (Inverted) Keynesian Logic

Florin O. Bilbiie

No 2005-W09, Economics Papers from Economics Group, Nuffield College, University of Oxford

Abstract: This paper incorporates limited asset markets participation in dynamic general equilibrium and develops a simple analytical framework for monetary policy analysis. Aggregate dynamics and stability properties of an otherwise standard business cycle model depend nonlinearly on the degree of asset market participation. While 'moderate' participation rates strengthen the role of monetary policy, low enough participation causes an inversion of results dictated by ('Keynesian') conventional wisdom. The slope of the 'IS' curve changes sign, the 'Taylor principle' is inverted, optimal welfare-maximizing monetary policy requires a passive policy rule and the effects and propagation of shocks are changed. The conditions for these results to hold are relatively mild compared to some existing empirical evidence. Our results may help explain the 'Great Inflation' and justify Fed behavior during that period.

Keywords: limited asset markets participation; dynamic general equilibrium; aggregate demand; Taylor Principle; optimal monetary policy; real (in)determinacy (search for similar items in EconPapers)
JEL-codes: E32 G11 E44 E31 E52 E58 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-fin, nep-mac and nep-mon
Date: 2005-03-01
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Persistent link: http://EconPapers.repec.org/RePEc:nuf:econwp:0509

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