Changes in the Output Euler Equation and Asset Markets Participation

Abstract : Recent estimates of the output Euler equation for the United States indicate that the elasticity of aggregate demand to interest rates is not significantly different from zero. We first argue that this result may hide a structural break: the estimated elasticity is a convolution of two coefficients with opposite signs across the samples 1965-1979 and 1982-2003. The sign of the coefficient in the earlier sample is inconsistent with standard economic theory and intuition. We outline a model with limited asset markets participation that can generate this change in sign when asset market participation changes from low to high, and provide institutional evidence for such a change in the United States in the late 70s and early 80s.
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Florin Bilbiie, Roland Straub. Changes in the Output Euler Equation and Asset Markets Participation. Journal of Economic Dynamics and Control, Elsevier, 2012, 36 (11), pp.1659-1672. ⟨10.1016/j.jedc.2012.03.018⟩. ⟨hal-00680647⟩

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