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Limited Asset Markets Participation, Monetary Policy and (Inverted) Keynesian Logic

This paper incorporates limited asset markets participation in dynamic general equilibrium and develops a simple analytical framework for monetary policy analysis. Aggregate dynamics and stability properties of an otherwise standard business cycle model depend nonlinearly on the degree of asset market participation. While 'moderate' participation rates strengthen the role of monetary policy, low enough participation causes an inversion of results dictated by ('Keynesian') conventional wisdom. The slope of the 'IS' curve changes sign, the 'Taylor principle' is inverted, optimal welfare-maximizing monetary policy requires a passive policy rule and the effects and propagation of shocks are changed. The conditions for these results to hold are relatively mild compared to some existing empirical evidence. Our results may help explain the 'Great Inflation' and justify Fed behavior during that period.

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File URL: http://www.nuffield.ox.ac.uk/economics/papers/2005/w9/LAMP_theory.pdf
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Paper provided by Economics Group, Nuffield College, University of Oxford in its series Economics Papers with number 2005-W09.

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Length: 42 pages
Date of creation: 01 Mar 2005
Date of revision:
Handle: RePEc:nuf:econwp:0509
Contact details of provider: Web page: http://www.nuff.ox.ac.uk/economics/

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