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Investment and interest rate policy in the open economy

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  • Stephen McKnight

Abstract

This paper analyses the necessary and sufficient conditions to ensure that interest rate policy does not introduce real indeterminacy and thus self-fulfilling fluctuations into open economies. A key feature of the model is the incorporation of capital and investment spending into the analysis. The conditions for real determinacy are examined for two measures of inflation that central banks' can target in open economies: domestic vs consumer price inflation. In stark contrast to previous studies, in the presence of investment activity monetary policy that targets domestic price inflation is more susceptible to self-fulfilling fluctuations than monetary policy rules that target consumer price inflation. However, the problem of indeterminacy identified under domestic price inflation can be ameliorated provided the policy rule also responds to either the exchange rate or to output. Copyright 2011 Oxford University Press 2011 All rights reserved, Oxford University Press.

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Bibliographic Info

Article provided by Oxford University Press in its journal Oxford Economic Papers.

Volume (Year): 63 (2011)
Issue (Month): 4 (December)
Pages: 673-699

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Handle: RePEc:oup:oxecpp:v:63:y:2011:i:4:p:673-699

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  1. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers 1908, C.E.P.R. Discussion Papers.
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  3. Batini, Nicoletta & Levine, Paul & Pearlman, Joseph G., 2004. "Indeterminacy with inflation-forecast-based rules in a two-bloc model," Working Paper Series 0340, European Central Bank.
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  7. James Bullard & Eric Schaling, 2009. "Monetary Policy, Determinacy, and Learnability in a Two-Block World Economy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(8), pages 1585-1612, December.
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  12. Charles T. Carlstrom & Timothy S. Fuerst, 2001. "Timing and real indeterminacy in monetary models," Working Paper 9910R, Federal Reserve Bank of Cleveland.
  13. Stephen McKnight, 2007. "Investment and Interest Rate Policy in the Open Economy," Economics & Management Discussion Papers em-dp2007-51, Henley Business School, Reading University.
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Citations

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Cited by:
  1. Stephen McKnight, 2007. "Investment and Interest Rate Policy in the Open Economy," Economic Analysis Research Group Working Papers earg-wp2007-11, Henley Business School, Reading University.
  2. Stephen McKnight & Alexander Mihailov, 2012. "Do real balance effects invalidate the Taylor principle in closed and open economies?," Serie documentos de trabajo del Centro de Estudios Económicos 2012-10, El Colegio de México, Centro de Estudios Económicos.
  3. Fujisaki, Seiya, 2013. "Taylor rules and equilibrium determinacy in a two-country model with non-traded goods," Economic Modelling, Elsevier, vol. 35(C), pages 597-603.
  4. Fujisaki, Seiya, 2012. "Taylor rules and equilibrium determinacy in a two-country model with non-traded goods," MPRA Paper 40023, University Library of Munich, Germany.
  5. Fujisaki, Seiya, 2012. "Interest Rate Control Rules and Macroeconomic Stability in a Heterogeneous Two-Country Model," MPRA Paper 37017, University Library of Munich, Germany.

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