Working Paper

Limited Participation in Equity Markets and Business Cycles

Abstract: This paper studies how the rise in US households' participation in equity markets affects the transmission of macroeconomic shocks to the economy. I embed limited participation into a New Keynesian framework for the US economy to analyze the individual and aggregate effects of higher participation. I derive three main results. First, participants are relatively more responsive to shocks than nonparticipants. Second, higher participation reduces the effectiveness of monetary policy. Third, with higher participation the economy becomes less volatile. I contrast key predictions of my model with new micro-level empirical evidence on the response of consumption to monetary policy shocks.

Keywords: Limited Participation; Monetary Policy; Stock Market; Investment; Business Cycle;

JEL Classification: E22; E32; E44; G51;

https://doi.org/10.17016/FEDS.2021.026

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2021-43-30

Number: 2021-026