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

  • Florin O. Bilbie

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 justify Fed`s behavior during the `Great Inflation` period.

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Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 2005-W09.

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Date of creation: 01 Mar 2005
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Handle: RePEc:oxf:wpaper:2005-w09
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