Savings, asset scarcity, and monetary policy

This paper analyzes optimal monetary policy regarding asset markets in a model where money and savings are essential and asset markets matter. The model is able to explain why different regimes for the correlation of real interest rates and stock price-dividend ratios exist, and offers two explanations why the correlation vanished after 2007: A decrease in inflation or changes in the supply of risky and safe assets. The results on optimal policy show that away from the Friedman rule, fiscal policy can improve welfare by increasing the amount of outstanding government debt. If the fiscal authority is not willing or able to increase debt, the monetary authority can improve welfare of current generations by reacting procyclically to asset return shocks.