This paper argues that limited asset market participation is crucial in explaining
U.S. macroeconomic performance and monetary policy before the 1980s, and their
changes thereafter. We develop an otherwise standard sticky-price DSGE model,
whereby at low enough asset market participation, standard aggregate demand logic
is inverted: interest rate increases become expansionary. Thereby, a passive monetary
policy rule ensures equilibrium determinacy and maximizes welfare, suggesting that
Federal Reserve policy in the pre-Volcker era was better than conventional wisdom
suggests. We provide empirical evidence consistent with this hypothesis, and study
the relative merits of changes in structure and shocks for reproducing the conquest of
the Great Inflation and the Great Moderation.