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Country‐Specific Risk Premium, Taylor Rules, and Exchange Rates

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  • Barbara Annicchiarico
  • Alessandro Piergallini

Abstract

The adoption of a Taylor-type monetary policy rule and an inflation target for emerging market economies that choose a flexible exchange rate regime is often advocated. This paper investigates the issue of exchange rate determination when interest-rate feedback rules are implemented in a continuous-time optimizing model of a small open economy facing an imperfect global capital market. It is demonstrated that when a risk premium on external debt affects the monetary policy transmission mechanism, the Taylor principle is not a necessary condition for determinacy of equilibrium. On the other hand, it is shown that exchange rate dynamics critically depends on whether monetary policy is active or passive.

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File URL: http://hdl.handle.net/10.1111/j.1468-0300.2011.00230.x
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Bibliographic Info

Article provided by Banca Monte dei Paschi di Siena SpA in its journal Economic Notes.

Volume (Year): 40 (2011)
Issue (Month): 1-2 (02)
Pages: 1-27

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Handle: RePEc:bla:ecnote:v:40:y:2011:i:1-2:p:1-27

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  1. Bianca De Paoli, 2009. "Monetary Policy Under Alterative Asset Market Structures: the Case of a Small Open Economy," CEP Discussion Papers dp0923, Centre for Economic Performance, LSE.
  2. Bennett T. McCallum, 2003. "Multiple-Solution Indeterminacies in Monetary Policy Analysis," NBER Working Papers 9837, National Bureau of Economic Research, Inc.
  3. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
  4. Jagdeep S. Bhandari & Nadeem Ul Haque & Stephen J. Turnovsky, 1990. "Growth, External Debt, and Sovereign Risk in a Small Open Economy," IMF Staff Papers, Palgrave Macmillan, vol. 37(2), pages 388-417, June.
  5. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  6. Robert G. King, 2000. "The new IS-LM model : language, logic, and limits," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 45-103.
  7. Stanley Fischer, 2001. "Exchange Rate Regimes: Is the Bipolar View Correct?," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 3-24, Spring.
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