Asset Market Participation, Monetary Policy Rules, and the Great Inflation
IMF Working Papers, September 1, 2006
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- Asset Market Participation, Monetary Policy Rules, and the Great Inflation
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Bibliographic details
- Authors: Florin Bilbiie, Roland Straub
- Published: September 1, 2006
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451864601.001
Core thesis
- Limited asset market participation is crucial in explaining U.S. macroeconomic performance and monetary policy before the 1980s, and their changes thereafter.
- At low asset-market participation rates, the interest rate elasticity of output (the slope of the IS curve) becomes positive — that is, "non-Keynesian."
- In that case, a passive monetary policy rule ensures equilibrium determinacy and maximizes welfare.
- The Federal Reserve System policy in the pre-Volcker era, often associated with a passive monetary policy rule, may have been closer to optimal than conventional wisdom suggests and may thus have remained unchanged at a fundamental level thereafter.
Model and mechanism
- Built on an otherwise standard sticky-price dynamic stochastic general equilibrium model.
- Key mechanism: low asset-market participation → positive slope of the IS curve (interest rate elasticity of output becomes positive).
- Policy implication from the model: passive monetary policy rules can produce determinate equilibria and welfare maximization when asset-market participation is limited.
Empirical strategy and evidence
- Institutional and empirical evidence are provided to support the hypothesis.
- Empirical estimation uses Bayesian estimation techniques.
- The model is shown to be able to explain most features of the "Great Inflation."
Findings and implications
- Limited asset market participation can reconcile observed pre-1980s U.S. macroeconomic behavior with a monetary policy that appears passive.
- Under limited participation, conventional prescriptions favoring active monetary policy may not be welfare-improving.
- Reassessment of the optimality of pre-Volcker-era Fed policy is warranted given the model’s implications.
Topics and keywords (as listed)
- Subjects: Consumption, Financial markets, Financial services, Hyperinflation, Inflation, National accounts, Prices, Real interest rates, Securities markets
- Keywords: aggregate demand, asset holder, asset market participation, Consumption, era estimate, Fed policy, Great Inflation, Hyperinflation, Inflation, interest rate, Limited Asset Market Participation, monetary policy, monetary policy rule, nominal interest rate, Passive Monetary Policy, Phillips curve, Real interest rates, Securities markets, WP
Source: Asset Market Participation, Monetary Policy Rules, and the Great Inflation — By Florin Bilbiie, Roland Straub; September 1, 2006; IMF Working Paper.