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Monetary Policy under Alternative Asset Market Structures: The Case of a Small Open Economy

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  • I would like to thank Gianluca Benigno, Anna Lipínska, and the anonymous referees for many helpful suggestions on the paper. This work was largely carried out before the author joined the Bank of England, and the views expressed in this paper are those of the author and do not necessarily reflect the views of this institution.

Abstract

Can the structure of asset markets change the way monetary policy should be conducted? Following a linear-quadratic approach, the present paper addresses this question in a New Keynesian small open economy framework. Our results reveal that the configuration of asset markets significantly affects optimal monetary policy and the performance of standard policy rules. In particular, when comparing complete and incomplete markets, the ranking of policy rules is entirely reversed, and so are the policy prescriptions regarding the optimal level of exchange rate volatility.

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