Optimal Monetary Responses to Asset Price Levels and Fluctuations: The Ramsey Problem and A Primal Approach

Diogo Guillen and Wei Cui ()
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Diogo Guillen: Princeton University

No 1106, 2012 Meeting Papers from Society for Economic Dynamics

Abstract: Should monetary policy react to asset prices levels and changes? In answering this question, we provide a tractable monetary Ramsey approach for a heterogeneous agents model with conventional policy (interest rate or money growth target) and unconventional policy (purchase of private illiquid assets) as instruments, in which heterogeneous agents' interaction is summarized in one implementability condition. We show that entrepreneurs hold too much liquid asset in a model with equity issuance and resale (liquidity) constraints. In the steady state, optimal policy involves paying interest on liquid assets or reducing the money supply available, leading to an equivalent increase of .40% in permanent consumption compared to the economy with no policy. In responding to liquidity shocks, the paths of macroeconomic variables under no policy and optimal policy are sharply different and suggest the need for policy on changing the rate of return on liquid assets. Finally, we prove that the unconventional policy dominates the conventional counterpart, but, quantitatively, the welfare difference of them is negligible.

Date: 2012
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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