Financial Development and the Distributional Effects of Monetary Policy Do the distributional consequences of monetary policy depend on the extent of financial development? Should optimal monetary policy vary across countries? In order to answer these questions, we develop a monetary growth production model with heterogeneous agents. In our economy, optimal policy needs to weigh the effects of policy across two groups — capital owners and individuals who hold liquid assets. While banks help limit the exposure to inflation, there are limits because money alleviates the frictions of private information and limited communication. In this environment, we compare two economies that are identical in every aspect except for their level of financial development. In a country with limited financial development, a stock market is absent. In the other, an equity market is active. In either economy, inflation adversely affects capital formation and output. Individuals who hold liquid assets are always adversely affected by inflation, but the attitude of capital owners depends on the level of financial development. In particular, in the presence of a stock market, the impact of inflation on the welfare of capital owners is non-monotonic. Nevertheless, optimal monetary policy is always more conservative at higher levels of financial development

Ghossoub, Edgar; Reedy, Robert

Financial Development and the Distributional Effects of Monetary Policy Do the distributional consequences of monetary policy depend on the extent of financial development? Should optimal monetary policy vary across countries? In order to answer these questions, we develop a monetary growth production model with heterogeneous agents. In our economy, optimal policy needs to weigh the effects of policy across two groups — capital owners and individuals who hold liquid assets. While banks help limit the exposure to inflation, there are limits because money alleviates the frictions of private information and limited communication. In this environment, we compare two economies that are identical in every aspect except for their level of financial development. In a country with limited financial development, a stock market is absent. In the other, an equity market is active. In either economy, inflation adversely affects capital formation and output. Individuals who hold liquid assets are always adversely affected by inflation, but the attitude of capital owners depends on the level of financial development. In particular, in the presence of a stock market, the impact of inflation on the welfare of capital owners is non-monotonic. Nevertheless, optimal monetary policy is always more conservative at higher levels of financial development

Edgar Ghossoub and Robert Reedy
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Edgar Ghossoub: The University of Texas at San Antonio
Robert Reedy: University of Alabama

No 35, Working Papers from College of Business, University of Texas at San Antonio

Keywords: Financial Development; Friedman Rule; Monetary Policy; Stock Market (search for similar items in EconPapers)
JEL-codes: E31 E44 E52 O16 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2012-08-16
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