Markets Segmentation and the Real Interest Rate Response to Monetary Policy Shocks

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Markets Segmentation and the Real Interest Rate Response to Monetary Policy Shocks

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Filippo Occhino () (Rutgers University)

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Filippo Occhino

Abstract

Following a contractionary monetary policy shock, the aggregate output decreases over time for six to eight quarters, while the real interest rate increases immediately and remains high for three quarters. Full participation models can hardly replicate the joint response of the aggregate output and the real interest rate, while limited participation models can do so only in the impact period. This paper adopts a segmented markets framework where some households are permanently excluded from financial markets. The monetary authority controls the short-term nominal interest rate, and lets the money supply be determined by the bond market. The aggregate output and the nominal interest rate are modeled as exogenous autoregressive processes, while the real interest rate is determined endogenously. When markets are segmented enough, the model is able to account for both the persistent decreasing path of the aggregate output and the persistent increase in the real interest rate which follow an unanticipated increase in the nominal interest rate. The sign, the size and the persistence of the responses of the real interest rate and the money growth rate are close to those in the data.

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Paper provided by Rutgers University, Department of Economics in its series Departmental Working Papers with number 200403.

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Length: 20 pages
Date of creation: 01 Feb 2004
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Handle: RePEc:rut:rutres:200403

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Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

This paper has been announced in the following NEP Reports:

NEP-ALL-2004-10-21 (All new papers)
NEP-CBA-2004-10-21 (Central Banking)
NEP-DGE-2004-10-21 (Dynamic General Equilibrium)
NEP-MON-2004-10-21 (Monetary Economics)

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