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Stability and Transitions in Emerging Market Policy Rules

Ashima Goyal and Shruti Tripathi
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Shruti Tripathi: National Institute of Public Finance and Policy, Delhi

Indian Economic Review, 2014, vol. 49, issue 2, 153-172

Abstract: Conditions for stability in an open economy dynamic stochastic general equilibrium model adapted to a dualistic labor market (SOEME) are the same as for a mature economy. But the introduction of monetary policy transmission lags makes it deviate from the Taylor Principle. Under rational expectations a policy rule is unstable, but under adaptive expectations traditional stabilization gives a determinate path, with weights on the objective of less than unity. Estimation of a Taylor rule for India and optimization in the SOEME model itself, all confirm the low weights. The results imply that under rational expectations, optimization is better than following a rule. If backward lookingbehavior dominates, however, a policy rule can prevent overshooting and instability. Economy-specific rigidities must inform policy design, and the appropriate design will change as the economy develops.

Keywords: DSGE; Emerging Market; Rigidities; Stability; Optimization; Taylor Rule (search for similar items in EconPapers)
JEL-codes: E26 E52 (search for similar items in EconPapers)
Date: 2014
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