Currency substitution, risk premia and the Taylor principle

Marco Airaudo ()

Journal of Economic Dynamics and Control, 2014, vol. 48, issue C, 202-217

Abstract: This paper studies the equilibrium determinacy properties of a simple interest rate rule in a small open economy subject to currency substitution (i.e., the use of a foreign currency for domestic transactions) and risk premia on foreign borrowing. It shows that if currencies are substitute in the provision of liquidity services the rule׳s response to inflation has to be sufficiently above unity for the equilibrium to be locally determinate. This reinforced Taylor principle requirement appears to be more binding in economies characterized by a larger elasticity of currency substitution, more debt-elastic country risk premia, and intermediate degrees of dollarization in transactions.

Keywords: Small open economy; Interest rate rules; Taylor principle; Determinacy; Currency substitution; Dollarization (search for similar items in EconPapers)
JEL-codes: E32 E52 F41 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:48:y:2014:i:c:p:202-217

DOI: 10.1016/j.jedc.2014.09.028

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