EconPapers    
Economics at your fingertips  
 

The Equity Premium, Long-Run Risk, & Optimal Monetary Policy

Anthony M. Diercks ()
Additional contact information
Anthony M. Diercks: Board of Governors of the Federal Reserve System (U.S.)

No 2015-87, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (US)

Abstract: In this study I examine the welfare implications of monetary policy by constructing a novel New Keynesian model that properly accounts for asset pricing facts. I find that the Ramsey optimal monetary policy yields an inflation rate above 3.5% and inflation volatility close to 1.5%. The same model calibrated to a counterfactually low equity premium implies an optimal inflation rate close to zero and inflation volatility less than 10 basis points, consistent with much of the existing literature. Relatively higher optimal inflation is due to the greater welfare costs of recessions associated with matching the equity premium. Additionally, the second order approximation allows monetary policy to have positive welfare effects on the labor share of income. I show that this channel is generally absent in standard macroeconomic models that do not take risk into account. Furthermore, the interest rate rule that comes closest to matching the dynamics of the optimal Ramsey policy puts a sizable weight on capital growth along with the price of capital, as it emphasizes stabilizing the medium to long term over the very short run.

Keywords: Asset Pricing; Long-run risk; Monetary policy (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
Date: 2015-09-21
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed

Downloads: (external link)
http://www.federalreserve.gov/econresdata/feds/2015/files/2015087pap.pdf Full text (application/pdf)
http://dx.doi.org/10.17016/FEDS.2015.087 http://dx.doi.org/10.17016/FEDS.2015.087 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2015-87

Ordering information: This working paper can be ordered from
http://www.federalre ... /feds/fedsorder.html

DOI: 10.17016/FEDS.2015.087

Access Statistics for this paper

More papers in Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (US) Contact information at EDIRC.
Bibliographic data for series maintained by Ryan Wolfslayer ().

 
Page updated 2019-11-18
Handle: RePEc:fip:fedgfe:2015-87