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

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Author Info

  • Guillermo A. Calvo

    (International Monetary Fund)

  • Carlos A. Végh

    (International Monetary Fund)

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.

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Bibliographic Info

Article provided by Palgrave Macmillan in its journal Staff Papers - International Monetary Fund.

Volume (Year): 37 (1990)
Issue (Month): 4 (December)
Pages: 753-776

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Handle: RePEc:pal:imfstp:v:37:y:1990:i:4:p:753-776

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Cited by:
  1. Michael Kumhof & Evan Tanner, 2005. "Government Debt," IMF Working Papers 05/57, International Monetary Fund.
  2. Calvo, Guillermo & Vegh, Carlos, 1991. "Exchange rate stabilization under imperfect credibility," MPRA Paper 20486, University Library of Munich, Germany.
  3. Gupta, Poonam, 2005. "Aftermath of banking crises: Effects on real and monetary variables," Journal of International Money and Finance, Elsevier, vol. 24(4), pages 675-691, June.
  4. Vegh, Carlos, 1991. "Stopping High Inflation: An Analytical Overview," MPRA Paper 20175, University Library of Munich, Germany.
  5. Talvi, Ernesto, 1997. "Exchange rate-based stabilization with endogenous fiscal response," Journal of Development Economics, Elsevier, vol. 54(1), pages 59-75, October.
  6. Reinhart, Carmen M. & Vegh, Carlos A., 1995. "Nominal interest rates, consumption booms, and lack of credibility: A quantitative examination," Journal of Development Economics, Elsevier, vol. 46(2), pages 357-378, April.
  7. Kumhof, Michael, 2000. "A quantitative exploration of the role of short-term domestic debt in balance of payments crises," Journal of International Economics, Elsevier, vol. 51(1), pages 195-215, June.
  8. Lopez Murphy, Ricardo & Navajas, Fernando, 1998. "Domestic savings, public savings and expenditures on consumer durable goods in Argentina," Journal of Development Economics, Elsevier, vol. 57(1), pages 97-116, October.

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