Model Misspecification, the Equilibrium Natural Interest Rate, and the Equity Premium
This paper analyzes the natural rate of interest and the equity premium in a nonlinear model where agents are uncertain over both future technology growth and the future course of monetary policy. I show that model uncertainty, and notably uncertainty on the future course of monetary policy, can give rise to a sizable precautionary savings motive. This result is potentially problematic for both the estimation of the natural rate and its use as a policy indicator. Monetary uncertainty can also contribute to amplify the equity premium, and to account for its apparent, positive link with inflation. Copyright (c) 2009 The Ohio State University.
Volume (Year): 41 (2009)
Issue (Month): 7 (October)
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