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CONSUMPTION EXTERNALITIES AND MONETARY POLICY WITH LIMITED ASSET MARKET PARTICIPATION
Author(s) -
Airaudo Marco,
Bossi Luca
Publication year - 2017
Publication title -
economic inquiry
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.823
H-Index - 72
eISSN - 1465-7295
pISSN - 0095-2583
DOI - 10.1111/ecin.12366
Subject(s) - economics , externality , taylor rule , consumption (sociology) , new keynesian economics , monetary policy , volatility (finance) , microeconomics , asset (computer security) , determinacy , general equilibrium theory , overlapping generations model , monetary economics , econometrics , central bank , social science , computer security , sociology , computer science , mathematical analysis , mathematics
This article explores the interaction between consumption externalities and limited asset market participation ( LAMP ) in the standard New‐Keynesian model. We assess the performance of simple Taylor‐type interest rate rules with respect to (a) equilibrium determinacy, (b) the model's ability to simultaneously generate output and inflation volatility similar to the pre‐Volcker era, and (c) the model's response to a technology shock. We find that when individual preferences are affected by average household consumption (Aggregate Consumption Externality), stronger externalities increase the range of LAMP for which multiple equilibria arise even if the policy rule satisfies the Taylor principle. The interaction of LAMP and externalities can generate vast inflation/output relative volatility in line with the one observed in the data in the 1970s. According to our analysis, consumption externalities also affect the responses of endogenous variables to total factor productivity shocks. ( JEL E4, E5)