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

Guillermo Calvo and Carlos Végh Gramont

No 1990/021, IMF Working Papers from International Monetary Fund

Abstract: An important hurdle in analyzing interest rate targeting is that standard models usually lead to price level or inflation rate indeterminacy. This paper develops a simple framework in which such problems do not arise because the bonds whose interest rate is controlled provide liquidity services. This framework is used to examine interest rate targeting in a small open economy under predetermined exchange rates. A permanent increase in the interest rate has no real effects. In contrast, a temporary increase in the interest rate leads to higher consumption and to a current account deficit that worsens over time.

Keywords: WP; nominal interest rate (search for similar items in EconPapers)
Pages: 32
Date: 1990-03-01
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Citations: View citations in EconPapers (11)

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