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Limited Asset Market Participation and Monetary Policy in a Small Open Economy

Author

Listed:
  • Paul Levine

    (University of Surrey)

  • Stephen McKnight

    (El Colegio de Mexico)

  • Alexander Mihailov

    (University of Reading)

  • Jonathan Swarbrick

    (University of St Andrews)

Abstract

Limited asset market participation (LAMP) and trade openness are crucial features that characterize all real-world economies. We study equilibrium determinacy and optimal monetary policy in a model of a small open economy with LAMP. With low enough participation in asset markets, the conventional wisdom concerning the stabilizing benefits of policy inertia can be overturned irrespective of the constraint of a zero lower bound on the nominal interest rate. In contrast to recent studies, in LAMP economies trade openness can play an important stabilizing role. We also show that the central bank must balance the opposing influence of openness and LAMP on the aggressiveness of optimal policy, and that the equivalence between efficient and equitable optimal allocation found in closed economies breaks down in open economies. We derive targeting rules and demonstrate the superiority of commitment over discretion in implementable optimal interest rate rules.

Suggested Citation

  • Paul Levine & Stephen McKnight & Alexander Mihailov & Jonathan Swarbrick, 2021. "Limited Asset Market Participation and Monetary Policy in a Small Open Economy," School of Economics Discussion Papers 0921, School of Economics, University of Surrey.
  • Handle: RePEc:sur:surrec:0921
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    File URL: https://repec.som.surrey.ac.uk/2021/DP09-21.pdf
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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