We consider a Diamond-type model of endogenous growth in which there are three assets: outside money, government bonds, and equity. Due to productivity shocks, the equity return is uncertain, and risk averse investors require a positive equity premium. Typically, there exist two steady states, but only one of them is stable, both in the forward perfect foresight dynamics and under adaptive expectations. Tight monetary policy is harmful for growth in the stable steady state. These results hold under four different monetary policy strategies applied by the monetary authority. A monetary contraction increases the bond return, reduces the equity premium and thereby capital investment and growth.
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Paper provided by Institute for Advanced Studies in its series Economics Series with number
86.
Find related papers by JEL classification: D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy O42 - Economic Development, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Monetary Growth Models
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