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This paper argues that limited asset market participation is crucial in explaining U.S. macroeconomic performance and monetary policy before the 1980s, and their changes thereafter. We develop an otherwise standard sticky-price dynamic stochastic general equilibrium model, which implies that at low asset-market participation rates, the interest rate elasticity of output (the slope of the IS curve) becomes positive - that is, "non-Keynesian." Remarkably, in that case, a passive monetary policy rule ensures equilibrium determinacy and maximizes welfare. Consequently, we argue that the policy of the Federal Reserve System in the pre-Volcker era, often associated with a passive monetary policy rule, was closer to optimal than conventional wisdom suggests and may thus have remained unchanged at a fundamental level thereafter. We provide institutional and empirical evidence for our hypothesis, in the latter case using Bayesian estimation techniques, and show that our model is able to explain most features of the "Great Inflation.".

Electronic books. -- local. --- Inflation (Finance). --- Monetary policy. --- Finance --- Business & Economics --- Money --- Inflation (Finance) --- Monetary management --- Economic policy --- Currency boards --- Money supply --- Natural rate of unemployment --- Banks and Banking --- Finance: General --- Inflation --- Macroeconomics --- Price Level --- Deflation --- Business Fluctuations --- Cycles --- Financial Markets and the Macroeconomy --- Monetary Policy --- Central Banks and Their Policies --- Studies of Particular Policy Episodes --- Economic History: Macroeconomics --- Growth and Fluctuations: U.S. --- Canada: 1913 --- -Economic History: Financial Markets and Institutions: U.S. --- General Financial Markets: General (includes Measurement and Data) --- Macroeconomics: Consumption --- Saving --- Wealth --- Interest Rates: Determination, Term Structure, and Effects --- Securities markets --- Consumption --- Hyperinflation --- Real interest rates --- Financial markets --- Prices --- National accounts --- Financial services --- Capital market --- Economics --- Interest rates --- United States