Financial Frictions and Optimal Monetary Policy in a Small Open Economy

Jesus Bejarano and Luisa F. Charry

No 12316, Borradores de Economia from Banco de la Republica

Abstract: In this paper we set up a small open economy model with financial frictions, following Curdia and Woodford (2010)’s model. Unlike other results in the literature such as Curdia and Woodford (2010), McCulley and Ramin (2008) and Taylor (2008), we find that optimal monetary policy should not respond to changes in domestic interest rate spreads when the source of fluctuations are exogenous financial shocks. A novel result here is that the optimal size of policy responses to changes in the credit spread is large when the disturbance source are shocks to the foreign interest rate. Our results suggest that such a response is welfare enhancing.

Keywords: Financial frictions; optimal interest rate rules; interest rate spreads; welfare; small open economy; second order approximation (search for similar items in EconPapers)
JEL-codes: E44 E50 E52 E58 F41 (search for similar items in EconPapers)
Pages: 45
Date: 2014-11-13
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Working Paper: Financial Frictions and Optimal Monetary Policy in a Small Open Economy (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:col:000094:012316

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