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Optimal monetary policy under incomplete markets and aggregate uncertainty: A long-run perspective

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  • Kryvtsov, Oleksiy
  • Shukayev, Malik
  • Ueberfeldt, Alexander

Abstract

This paper examines the role of monetary policy in an environment with aggregate risk and incomplete markets. In a two-period overlapping-generations model with aggregate uncertainty, optimal monetary policy attains the ex-ante Pareto optimal allocation. This policy aims to stabilize the savings rate in the economy by changing real returns of nominal bonds via variation in expected inflation. Optimal expected inflation is procylical and on average higher than without uncertainty. Simple inflation targeting rules closely approximate the optimal monetary policy.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 35 (2011)
Issue (Month): 7 (July)
Pages: 1045-1060

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Handle: RePEc:eee:dyncon:v:35:y:2011:i:7:p:1045-1060

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Web page: http://www.elsevier.com/locate/jedc

Related research

Keywords: Optimal monetary policy Inflation targeting;

References

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  1. Bhattacharya, Joydeep & Singh, Rajesh, 2008. "Optimal Monetary Policy Rules Under Persistent Shocks," Staff General Research Papers 12863, Iowa State University, Department of Economics.
  2. Krusell, P & Smith Jr, A-A, 1995. "Income and Wealth Heterogeneity in the Macroeconomic," RCER Working Papers 399, University of Rochester - Center for Economic Research (RCER).
  3. Doepke, Matthias & Schneider, Martin, 2006. "Aggregate Implications of Wealth Redistribution: The Case of Inflation," CEPR Discussion Papers 5552, C.E.P.R. Discussion Papers.
  4. Lars Ljungqvist & Thomas J. Sargent, 2004. "Recursive Macroeconomic Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 026212274x, December.
  5. Peter A. Diamond, 1965. "On the Cost of Tax-exempt Bonds," Journal of Political Economy, University of Chicago Press, vol. 73, pages 399.
  6. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
  7. Milton Friedman, 1957. "Introduction to "A Theory of the Consumption Function"," NBER Chapters, in: A Theory of the Consumption Function, pages 1-6 National Bureau of Economic Research, Inc.
  8. Bhattacharya, Joydeep & Singh, Rajesh, 2010. "Optimal monetary rules under persistent shocks," Journal of Economic Dynamics and Control, Elsevier, vol. 34(7), pages 1277-1294, July.
  9. Akyol, Ahmet, 2004. "Optimal monetary policy in an economy with incomplete markets and idiosyncratic risk," Journal of Monetary Economics, Elsevier, vol. 51(6), pages 1245-1269, September.
  10. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, May.
  11. Champ,Bruce & Freeman,Scott & Haslag,Joseph, 2011. "Modeling Monetary Economies," Cambridge Books, Cambridge University Press, number 9781107003491, October.
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