Limited asset market participation and monetary policy in a small open economy

Paul Levine, Stephen McKnight, Alexander Mihailov, Jonathan Swarbrick*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

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, 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, trade openness can play an important stabilizing role in LAMP economies. Optimal monetary policy is derived as a robust timeless rule, where the optimal level of interest-rate inertia depends on the degree of trade openness. The optimal rule is shown to be super-inertial for standard economies, whereas the degree of inertia is significantly lower and not super-inertial for LAMP economies.
Original languageEnglish
Article number105047
Number of pages20
JournalJournal of Economic Dynamics and Control
Volume173
Early online date27 Jan 2025
DOIs
Publication statusE-pub ahead of print - 27 Jan 2025

Keywords

  • Limited asset market participation
  • Small open economy
  • Inverted aggregate demand logic
  • Equilibrium determinancy
  • Interest-rate inertia
  • Optimal monetary policy

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