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Asset Market Participation, Monetary Policy Rules, and the Great Inflation

  • Florin O. Bilbiie

    (Paris School of Economics, Université Paris 1 Panthéon-Sorbonne, and CEPR)

  • Roland Straub

    (European Central Bank)

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, and 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. © 2013 The President and Fellows of Harvard College and the Massachusetts Institute of Technology.

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Article provided by MIT Press in its journal Review of Economics and Statistics.

Volume (Year): 95 (2013)
Issue (Month): 2 (May)
Pages: 377-392

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Handle: RePEc:tpr:restat:v:95:y:2013:i:2:p:377-392
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