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Asset Market Participation, Monetary Policy Rules and the Great Inflation

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  • Bilbiie, Florin Ovidiu
  • Straub, Roland

Abstract

This paper argues that limited asset market participation is crucial in explaining U.S. macroeconomic performance and monetary policy before the 1980s, and their changes thereafter. We develop an otherwise standard sticky-price DSGE model, whereby at low enough asset market participation, standard aggregate demand logic is inverted: interest rate increases become expansionary. Thereby, a passive monetary policy rule ensures equilibrium determinacy and maximizes welfare, suggesting that Federal Reserve policy in the pre-Volcker era was better than conventional wisdom suggests. We provide empirical evidence consistent with this hypothesis, and study the relative merits of changes in structure and shocks for reproducing the conquest of the Great Inflation and the Great Moderation.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8555.

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Date of creation: Sep 2011
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Handle: RePEc:cpr:ceprdp:8555

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Keywords: aggregate demand; Bayesian estimation; Great Inflation; Great Moderation; limited asset markets participation; passive monetary policy rules; real (in)determinacy;

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Cited by:
  1. Jordi Galí & J. David López-Salido & Javier Vallés, 2002. "Understanding the effects of government spending on consumption," Economics Working Papers 911, Department of Economics and Business, Universitat Pompeu Fabra, revised Aug 2005.
  2. Canzoneri, Matthew & Cumby, Robert & Diba, Behzad & López-Salido, David, 2011. "The role of liquid government bonds in the great transformation of American monetary policy," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 35(3), pages 282-294, March.
  3. Florin Bilbiie & Tommaso Monacelli & Roberto Perotti, 2012. "Public Debt and Redistribution with Borrowing Constraints," Working Papers 435, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  4. B. Hofmann & G. Peersman & R. Straub, 2010. "Time Variation in U.S. Wage Dynamics," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium, Ghent University, Faculty of Economics and Business Administration 10/691, Ghent University, Faculty of Economics and Business Administration.
  5. Florin Bilbiie & Roland Straub, 2012. "Changes in the Output Euler Equation and Asset Markets Participation," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-00680647, HAL.
  6. Barnett, Alina & Straub, Roland, 2008. "What drives U.S. current account fluctuations?," Working Paper Series, European Central Bank 0959, European Central Bank.

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