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Inspecting Monetary Policy Rules in a Small Open Economy with Financial Frictions

Author

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  • Jung, Yongseung

    (Kyung Hee University)

Abstract

In this paper, we address how the monetary authority should react to financial market status and exchange rates movements in a small open economy New Keynesian model with financial frictions due to asymmetric information between savers and borrowers. We show that the small economy with financial frictions is more susceptible to the exogenous shocks under the fixed exchange rate regime than under the flexible exchange regime. The small economy experiences a more prolonged and deeper economic recession under the fixed exchange rate regime than under the flexible exchange rate regime. The monetary policy taking into account external finance premium is better than the interest rate rule without considering the financial market status.

Suggested Citation

  • Jung, Yongseung, 2023. "Inspecting Monetary Policy Rules in a Small Open Economy with Financial Frictions," East Asian Economic Review, Korea Institute for International Economic Policy, vol. 27(2), pages 115-143, June.
    • Handle: RePEc:ris:eaerev:0420
    DOI: 10.11644/KIEP.EAER.2023.27.2.420
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    Keywords

    Financial Frictions; Monetary Policy; Small Open Economy; Welfare Loss;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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