Interest Rate Policy in a Small Open Economy: The Predetermined Exchange Rates Case

Guillermo Calvo and Carlos A. Végh
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Carlos A. Végh: International Monetary Fund

IMF Staff Papers, 1990, vol. 37, issue 4, 753-776

Abstract: An important obstacle encountered in analyzing interest rate targeting is that standard models usually lead to indeterminacy of the price level or the inflation rate. This paper develops a simple framework that avoids such problems, because the bonds whose interest rate is controlled provide liquidity services. This framework is used to examine interest rate policy in a small open economy under predetermined exchange rates. A permanent increase in the interest rate has no real effects, whereas a temporary increase in the interest rate leads to higher consumption and a current account deficit that worsens over time.

Date: 1990
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Persistent link: https://EconPapers.repec.org/RePEc:pal:imfstp:v:37:y:1990:i:4:p:753-776

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