Capital Inflows, Dutch Disease Effects, and Monetary Policy in a Small Open Economy

Emmanuel Lartey

Review of International Economics, 2008, vol. 16, issue 5, 971-989

Abstract: This paper studies the role of monetary policy in a small open economy that experiences Dutch disease effects as a result of capital inflows, and examines the issue of whether such a policy should seek to address these effects from a welfare perspective. I find that Dutch disease effects occur under a fixed nominal exchange rate regime. However, a monetary policy regime characterized by generalized Taylor interest rate rules featuring either the real exchange rate or the nominal exchange rate avert Dutch disease effects. Welfare results reveal that the optimal rule is a generalized Taylor rule consistent with nominal exchange rate flexibility.

Date: 2008
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https://doi.org/10.1111/j.1467-9396.2008.00762.x

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