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Interest Rate Rules, Endogenous Cycles, and Chaotic Dynamics in Open Economies

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  • Marco Airaudo
  • Luis-Felipe Zanna
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    Abstract

    In this paper we present an extensive analysis of the consequences for global equilibrium determinacy in flexible-price open economies of implementing active interest rate rules, i.e., monetary rules where the nominal interest rate responds more than proportionally to changes in inflation. We show that conditions under which these rules generate aggregate instability by inducing liquidity traps, endogenous cycles, and chaotic dynamics depend on particular characteristics of open economies, including the degree of trade openness and the degree of exchange rate pass-through into import prices. For instance, in our model, we find that a rule that responds to expected future inflation is more prone to induce endogenous cyclical and chaotic dynamics the more open the economy and the higher the degree of exchange rate pass-through.

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    File URL: http://www.carloalberto.org/assets/working-papers/no.171.pdf
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    Bibliographic Info

    Paper provided by Collegio Carlo Alberto in its series Carlo Alberto Notebooks with number 171.

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    Length: 40 pages
    Date of creation: 2010
    Date of revision:
    Handle: RePEc:cca:wpaper:171

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    Related research

    Keywords: Small Open Economy; Interest Rate Rules; Taylor Rules; Multiple Equilibria; Chaos; Endogenous Fluctuations;

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    1. De Fiore, Fiorella & Liu, Zheng, 2005. "Does trade openness matter for aggregate instability?," Journal of Economic Dynamics and Control, Elsevier, vol. 29(7), pages 1165-1192, July.
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