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Optimal Monetary Responses to Asset Price Levels and Fluctuations: The Ramsey Problem and A Primal Approach

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  • Diogo Guillen

    (Princeton University)

  • Wei Cui

    (Princeton University)

Abstract

Should monetary policy react to asset prices levels and changes? In answering this question, we provide a tractable monetary Ramsey approach for a heterogeneous agents model with conventional policy (interest rate or money growth target) and unconventional policy (purchase of private illiquid assets) as instruments, in which heterogeneous agents' interaction is summarized in one implementability condition. We show that entrepreneurs hold too much liquid asset in a model with equity issuance and resale (liquidity) constraints. In the steady state, optimal policy involves paying interest on liquid assets or reducing the money supply available, leading to an equivalent increase of .40% in permanent consumption compared to the economy with no policy. In responding to liquidity shocks, the paths of macroeconomic variables under no policy and optimal policy are sharply different and suggest the need for policy on changing the rate of return on liquid assets. Finally, we prove that the unconventional policy dominates the conventional counterpart, but, quantitatively, the welfare difference of them is negligible.

Suggested Citation

  • Diogo Guillen & Wei Cui, 2012. "Optimal Monetary Responses to Asset Price Levels and Fluctuations: The Ramsey Problem and A Primal Approach," 2012 Meeting Papers 1106, Society for Economic Dynamics.
  • Handle: RePEc:red:sed012:1106
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    References listed on IDEAS

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    1. Javier Bianchi, 2011. "Overborrowing and Systemic Externalities in the Business Cycle," American Economic Review, American Economic Association, vol. 101(7), pages 3400-3426, December.
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    3. Julia K. Thomas, 2002. "Is Lumpy Investment Relevant for the Business Cycle?," Journal of Political Economy, University of Chicago Press, vol. 110(3), pages 508-534, June.
    4. Mankiw, N. Gregory & Zeldes, Stephen P., 1991. "The consumption of stockholders and nonstockholders," Journal of Financial Economics, Elsevier, vol. 29(1), pages 97-112, March.
    5. S. Rao Aiyagari, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, Oxford University Press, vol. 109(3), pages 659-684.
    6. Marco Del Negro & Gauti Eggertsson & Andrea Ferrero & Nobuhiro Kiyotaki, 2017. "The Great Escape? A Quantitative Evaluation of the Fed's Liquidity Facilities," American Economic Review, American Economic Association, vol. 107(3), pages 824-857, March.
    7. John Haltiwanger & Russell Cooper & Laura Power, 1999. "Machine Replacement and the Business Cycle: Lumps and Bumps," American Economic Review, American Economic Association, vol. 89(4), pages 921-946, September.
    8. Gertler, Mark & Karadi, Peter, 2011. "A model of unconventional monetary policy," Journal of Monetary Economics, Elsevier, vol. 58(1), pages 17-34, January.
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