Interest rate rules and equilibrium (in)determinacy in a small open economy: the role of internationally traded capital

Chang Wen-ya, Tsai Hsueh-fang, Juin-jen Chang and Lin Hsieh-yu
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Chang Wen-ya: Fu-Jen Catholic University, Taipei, Taiwan
Tsai Hsueh-fang: Fu-Jen Catholic University, Taipei, Taiwan
Lin Hsieh-yu: Academia Sinica, Taipei, Taiwan

The B.E. Journal of Macroeconomics, 2018, vol. 18, issue 2, 18

Abstract: This study develops a small-open-economy version of Benhabib, J., S. Schmitt-Grohé, and M. Uribe. 2001. “Monetary Policy and Multiple Equilibria.” American Economic Review 91: 167–186. We systematically explore the role of international capital mobility and the portfolio balance channel in terms of macroeconomic (in)stability when the government follows a commonly-adopted interest-rate feedback rule. In a one-traded-good model, the steady-state equilibrium, in general, is locally determinate; international capital mobility stabilizes the economy against business cycle fluctuations under a simple interest-rate feedback rule. In a two-good (traded and non-traded goods) model, the relationship between equilibrium (in)determinacy and the aggressiveness of interest rate rules is not monotonic, and crucially depends on households’ portfolio preferences. These results suggest that a unified interest rate rule can end up with very different consequences of macroeconomic (in)stability in an open economy from those in a closed economy.

Keywords: indeterminacy; interest rate rules; international capital mobility; portfolio preference (search for similar items in EconPapers)
JEL-codes: E31 E52 F41 (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1515/bejm-2016-0128

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