Re-examining the Importance of Trade Openness for Aggregate Instability

Stephen McKnight () and Alexander Mihailov ()

No em-dp2007-52, Economics & Management Discussion Papers from Henley Business School, Reading University

Abstract: This paper re-considers the importance of trade openness for equilibrium determinacy when monetary policy is characterized by interest-rate rules. We develop a two-country, sticky-price model where money enters the utility function in a non-separable manner. Forward- and current-looking policy rules that react to domestic or consumer price inflation are analyzed. It is shown that the introduction of real balance effects substantially limits the validity of the Taylor principle and challenges recent conclusions concerning the relative desirability of the inflation indicator targeted.

Keywords: Real indeterminacy; Open-economy macroeconomics; Interest-rate rules; Monetary policy (search for similar items in EconPapers)
JEL-codes: E32 E43 E53 E58 F41 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba and nep-mac
Date: 2007-10
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Working Paper: Re-examining the Importance of Trade Openness for Aggregate Instability (2007)
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