Monetary Policy in the Great Depression : a Two-Agent New Keynesian Approach.

Details

Supervisors

Pensieroso, Luca

Faculty

Faculté des sciences économiques, sociales, politiques et de communication

Degree label

Master [120] en sciences économiques, orientation générale, à finalité approfondie

Abstract

This paper attempts to shed new light on the conduct of monetary policy during the Great Depression, through the prism of a Two-Agent New Keynesian model. We refer in particular to the theoretical framework developed by Bilbiie (2008). In this model, the standard demand logic is inverted if the share of liquidity-constrained agents is high enough. When this occurs, the slope of the IS curve is upward, and an increase in the real rate of interest becomes expansionary. Additionally, the Central Bank must conduct a "passive" monetary policy to rule out the possibility of multiple equilibria. To justify the use of this model, we provide substantial empirical evidence of limited asset market participation during the 1930s. The historical variance decomposition confirms the importance of demand shocks in the onset and recovery of the Great Depression. In particular, monetary shocks seem to play no role at all, contradicting the hypothesis of Friedman-Schwartz (1963). Our paper provides then new insights into the Federal Reserve's behavior during the Great Depression : the monetary policy - implicitly characterized by a "passive" Taylor rule - was effectively executed by the Federal Reserve, given the relatively high proportion of liquidity-constrained households in the population.