Markets Segmentation and the Real Interest Rate Response to Monetary Policy Shocks

Filippo Occhino

Departmental Working Papers from Rutgers University, Department of Economics

Abstract: Following a contractionary monetary policy shock, the aggregate output decreases over time for six to eight quarters, while the real interest rate increases immediately and remains high for three quarters. Full participation models can hardly replicate the joint response of the aggregate output and the real interest rate, while limited participation models can do so only in the impact period. This paper adopts a segmented markets framework where some households are permanently excluded from financial markets. The monetary authority controls the short-term nominal interest rate, and lets the money supply be determined by the bond market. The aggregate output and the nominal interest rate are modeled as exogenous autoregressive processes, while the real interest rate is determined endogenously. When markets are segmented enough, the model is able to account for both the persistent decreasing path of the aggregate output and the persistent increase in the real interest rate which follow an unanticipated increase in the nominal interest rate. The sign, the size and the persistence of the responses of the real interest rate and the money growth rate are close to those in the data.

Keywords: limited participation; markets segmentation; monetary poliy shocks; real interest rate (search for similar items in EconPapers)
JEL-codes: E52 (search for similar items in EconPapers)
Pages: 20 pages
Date: 2004-02-01
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:rut:rutres:200403

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