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

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  • Filippo Occhino

    () (Rutgers University)

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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Bibliographic Info

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
Date of revision:
Handle: RePEc:rut:rutres:200403

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Keywords: limited participation; markets segmentation; monetary poliy shocks; real interest rate;

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  1. Uhlig, Harald, 1999. "What are the Effects of Monetary Policy on Output? Results from an Agnostic Identification Procedure," CEPR Discussion Papers 2137, C.E.P.R. Discussion Papers.
  2. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  3. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1998. "Monetary Policy Shocks: What Have We Learned and to What End?," NBER Working Papers 6400, National Bureau of Economic Research, Inc.
  4. Amartya Lahiri & Rajesh Singh & Carlos A. Vegh, 2007. "Segmented Asset Markets and Optimal Exchange Rate Regimes," NBER Working Papers 13154, National Bureau of Economic Research, Inc.
  5. Robert E. Lucas Jr. & Nancy L. Stokey, 1984. "Money and Interest in Cash-In-Advance Economy," Discussion Papers 628, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  6. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
  7. Fernando Alvarez & Andrew Atkeson & Patrick J. Kehoe, 2000. "Money, interest rates, and exchange rates with endogenously segmented markets," Staff Report 278, Federal Reserve Bank of Minneapolis.
  8. Grossman, Sanford & Weiss, Laurence, 1983. "A Transactions-Based Model of the Monetary Transmission Mechanism," American Economic Review, American Economic Association, vol. 73(5), pages 871-80, December.
  9. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
  10. Ben S. Bernanke & Ilian Mihov, 1995. "Measuring monetary policy," Working Papers in Applied Economic Theory 95-09, Federal Reserve Bank of San Francisco.
  11. Lawrence J. Christiano & Martin Eichenbaum, 1992. "Liquidity effects and the monetary transmission mechanism," Staff Report 150, Federal Reserve Bank of Minneapolis.
  12. Fuerst, Timothy S., 1992. "Liquidity, loanable funds, and real activity," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 3-24, February.
  13. Strongin, Steven, 1995. "The identification of monetary policy disturbances explaining the liquidity puzzle," Journal of Monetary Economics, Elsevier, vol. 35(3), pages 463-497, June.
  14. Filippo Occhino, 2004. "Modeling the Response of Money and Interest Rates to Monetary Policy Shocks: A Segmented Markets Approach," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(1), pages 181-197, January.
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