Savings, asset scarcity, and monetary policy

This paper analyzes optimal monetary policy regarding asset markets in a model where money and savings are essential and asset markets matter. The model is able to explain why different regimes for the correlation of real interest rates and stock price-dividend ratios exist, and offers two explanations why the correlation vanished after 2007: A decrease in inflation or changes in the supply of risky and safe assets. The results on optimal policy show that away from the Friedman rule, fiscal policy can improve welfare by increasing the amount of outstanding government debt. If the fiscal authority is not willing or able to increase debt, the monetary authority can improve welfare of current generations by reacting procyclically to asset return shocks.

[1]  T. Bewley,et al.  A DIFFICULTY WITH THE OPTIMUM QUANTITY OF MONEY , 1983 .

[2]  Lucas Herrenbrueck,et al.  Asset Safety versus Asset Liquidity , 2018, Journal of Political Economy.

[3]  Athanasios Geromichalos,et al.  Monetary policy and asset prices , 2007 .

[4]  Gauti B. Eggertsson,et al.  Debt, Deleveraging and the Liquidity Trap , 2011 .

[5]  Nicolas L. Jacquet,et al.  Money, Bargaining, and Risk Sharing , 2011 .

[6]  Jesús Sierra.  International Capital Flows and Bond Risk , 2010 .

[7]  Ricardo J. Caballero,et al.  The Safety Trap , 2014 .

[8]  Stephen D. Williamson.  Liquidity, Monetary Policy, and the Financial Crisis: A New Monetarist Approach , 2012 .

[9]  A. Krishnamurthy,et al.  A Model of the Reserve Asset , 2015 .

[10]  Alan M. Taylor,et al.  Credit Booms Gone Bust: Monetary Policy, Leverage Cycles and Financial Crises, 1870-2008 , 2009 .

[11]  Ricardo J. Caballero,et al.  The Safe Assets Shortage Conundrum , 2017 .

[12]  B. Bernanke.  The global saving glut and the U.S. current account deficit , 2005 .

[13]  J. Stein.  Monetary Policy as Financial-Stability Regulation , 2011 .

[14]  Sylvia Xiaolin Xiao,et al.  Open market operations , 2018, Journal of Monetary Economics.

[15]  Randall Wright,et al.  Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium , 2003 .

[16]  Gustavo A. Suarez,et al.  The Evolution of a Financial Crisis: Collapse of the Asset-Backed Commercial Paper Market , 2012 .

[17]  Lucas Herrenbrueck,et al.  The Liquidity-Augmented Model of Macroeconomic Aggregates , 2017 .

[18]  Ricardo Lagos,et al.  Asset prices and liquidity in an exchange economy , 2010 .

[19]  I. Fisher,et al.  The theory of interest , 1956 .

[20]  D. Andolfatto.  Incentive-Feasible Deflation , 2012 .

[21]  Andrea Ajello,et al.  Divisions of Research & Statistics and Monetary Affairs Federal Reserve Board , Washington , D . C . Financial Stability and Optimal Interest-Rate Policy , 2016 .

[22]  John B. Taylor.  The Role of Policy in the Great Recession and the Weak Recovery , 2014 .

[23]  Christopher J. Waller.  Dynamic Taxation, Private Information and Money , 2009 .

[24]  Jagdish Handa,et al.  The overlapping generations model of fiat money , 2000 .

[25]  Gauti B. Eggertsson,et al.  Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach* , 2012 .

[26]  S. Nisticò.  Monetary policy and stock-price dynamics in a DSGE framework , 2012 .

[27]  Marcel Fratzscher,et al.  The Pricing of Sovereign Risk and Contagion During the European Sovereign Debt Crisis , 2012, SSRN Electronic Journal.

[28]  J. Galí,et al.  NBER WORKING PAPER SERIES MONETARY POLICY AND BUBBLES IN A NEW KEYNESIAN MODEL WITH OVERLAPPING GENERATIONS , 2020 .

[29]  Optimal Fiscal and Monetary Policy When Money is Essential , 2006 .

[30]  Ben S. Bernanke,et al.  Should Central Banks Respond to Movements in Asset Prices , 2001 .

[31]  Andrew Postlewaite,et al.  Information, Liquidity, Asset Prices, and Monetary Policy , 2012 .

[32]  Stephen D. Williamson.  Scarce Collateral, the Term Premium, and Quantitative Easing , 2014, J. Econ. Theory.

[33]  Gauti B. Eggertsson,et al.  Policy Options in a Liquidity Trap , 2004 .

[34]  J. Galí.  Monetary Policy and Rational Asset Price Bubbles , 2013 .

[35]  Lukas Altermatt.  Inside Money, Investment, and Unconventional Monetary Policy , 2019, International Economic Review.

[36]  Tao Zhu.  An overlapping-generations model with search ∗ , 2008 .

[37]  B. Bernanke,et al.  International Capital Flows and the Return to Safe Assets in the United States, 2003-2007 , 2011 .

[38]  Paul Krugman,et al.  It's Baaack: Japan's Slump and the Return of the Liquidity Trap , 1998 .

[39]  Adrian Peralta-Alva,et al.  Optimal Monetary and Fiscal Policies in a Search Theoretic Model of Monetary Exchange , 2008 .

[40]  J. Tirole.  ASSET BUBBLES AND OVERLAPPING GENERATIONS , 1985 .

[41]  Gauti B. Eggertsson,et al.  Zero Bound on Interest Rates and Optimal Monetary Policy , 2003, Brookings Papers on Economic Activity.

[42]  J. Cochrane.  The New-Keynesian Liquidity Trap , 2013 .

[43]  Guido Lorenzoni,et al.  Credit Crises, Precautionary Savings, and the Liquidity Trap , 2011 .

[44]  Christopher J. Waller,et al.  OPTIMAL STABILIZATION POLICY WITH SEARCH EXTERNALITIES , 2013, Macroeconomic Dynamics.

[45]  Ricardo J. Caballero,et al.  Global Imbalances and Financial Fragility , 2009 .

[46]  Ricardo Lagos,et al.  A Unified Framework for Monetary Theory and Policy Analysis , 2005 .