Inspecting Monetary Policy Rules in a Small Open Economy with Financial Frictions

Yongseung Jung ()
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Yongseung Jung: Kyung Hee University

East Asian Economic Review, 2023, vol. 27, issue 2, 115-143

Abstract: In this paper, we address how the monetary authority should react to financial market status and exchange rates movements in a small open economy New Keynesian model with financial frictions due to asymmetric information between savers and borrowers. We show that the small economy with financial frictions is more susceptible to the exogenous shocks under the fixed exchange rate regime than under the flexible exchange regime. The small economy experiences a more prolonged and deeper economic recession under the fixed exchange rate regime than under the flexible exchange rate regime. The monetary policy taking into account external finance premium is better than the interest rate rule without considering the financial market status.

Keywords: Financial Frictions; Monetary Policy; Small Open Economy; Welfare Loss (search for similar items in EconPapers)
JEL-codes: E52 F41 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:ris:eaerev:0420

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