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Asset market participation, monetary policy rules and the great inflation

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  • Bilbiie, Florin O.
  • 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. In an otherwise conventional sticky-price model, standard aggregate demand logic is inverted at low enough asset market participation: interest rate increases become expansionary; passive monetary policy ensures equilibrium determinacy and maximizes welfare. This suggests that Federal Reserve policy in the pre-Volcker era was better than conventional wisdom implies. 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. JEL Classification: E310, E320, E440, E520

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 1438.

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Date of creation: May 2012
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Handle: RePEc:ecb:ecbwps:20121438

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Keywords: Great Inflation; Great Moderation; limited asset markets participation; passive monetary policy rules;

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Citations

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Cited by:
  1. Roland Straub & Gert Peersman & Boris Hofmann, 2011. "Time Variation in U.S. Wage Dynamics," 2011 Meeting Papers 331, Society for Economic Dynamics.
  2. 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.
  3. 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.
  4. Barnett, Alina & Straub, Roland, 2008. "What drives U.S. current account fluctuations?," Working Paper Series 0959, European Central Bank.
  5. 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, vol. 35(3), pages 282-294, March.

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