The Cost Of Capital, Asset Prices And The Affects Of Monetary Policy

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Executive Summary

The primary objective of this paper is to study the interaction between monetary policy, asset prices, and the sources of technological progress. The authors develop a two sector model in which financial institutions promote risk sharing and fiat money alleviates trade frictions. Since the price of capital goods depends on inflation, the Friedman Rule may be sub-optimal. In addition, different sources of productivity can affect the degree of risk sharing. Although the optimal money growth rate falls in response to an increase in productivity in either sector of the economy, monetary policy should react more aggressively to investment-specific productivity.

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