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

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  • Luis-Felipe Zanna
  • Marco Airaudo
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    Abstract

    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 inflation. We show that conditions under which these rules generate aggregate instability by inducing liquidity traps, endogenous cycles, and chaotic dynamics depend on specific characteristics of open economies. In particular, rules that respond to expected future inflation are more prone to induce endogenous cyclical and chaotic dynamics the more open the economy to trade.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 12/121.

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    Length: 40
    Date of creation: 01 May 2012
    Date of revision:
    Handle: RePEc:imf:imfwpa:12/121

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    Related research

    Keywords: Economic models; Interest rates; Real effective exchange rates; inflation; nominal interest rate; open economy; monetary policy; trade openness; open economies; closed economy; real money; monetary economics; import prices; foreign currency; inflation targeting; real interest rate; nominal interest rates; international trade; terms of trade; real exchange rates; macroeconomic stability; closed economies; effective exchange rates; political economy; inflation rates; inflation rate; steady-state inflation; elasticity of substitution; effects of inflation; macroeconomic performance; aggregate consumption; rational expectations;

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    References

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    1. Evans, G.W. & Guse, E. & Honkapohja, S, 2007. "Liquidity Traps, Learning and Stagnation," Cambridge Working Papers in Economics, Faculty of Economics, University of Cambridge 0732, Faculty of Economics, University of Cambridge.
    2. Ragna Alstadheim & Dale W. Henderson, 2004. "Price-level determinacy, lower bounds on the nominal interest rate, and liquidity traps," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 795, Board of Governors of the Federal Reserve System (U.S.).
    3. Bask, Mikael, 2000. "A Positive Lyapunov Exponent in Swedish Exchange Rates?," UmeÃ¥ Economic Studies, UmeÃ¥ University, Department of Economics 528, Umeå University, Department of Economics.
    4. Bullard, James & Singh, Aarti, 2008. "Worldwide macroeconomic stability and monetary policy rules," Journal of Monetary Economics, Elsevier, Elsevier, vol. 55(Supplemen), pages S34-S47, October.
    5. Campbell Leith & Simon Wren-Lewis, 2002. "Taylor Rules in the Open Economy," Working Papers, Business School - Economics, University of Glasgow 2002_14, Business School - Economics, University of Glasgow.
    6. Stefano Eusepi, 2005. "Comparing forecast-based and backward-looking Taylor rules: a "global" analysis," Staff Reports, Federal Reserve Bank of New York 198, Federal Reserve Bank of New York.
    7. Luis-Gonzalo Llosa & Vicente Tuesta, 2008. "Determinacy and Learnability of Monetary Policy Rules in Small Open Economies," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 40(5), pages 1033-1063, 08.
    8. Diks, C.G.H. & Hommes, C.H. & Panchenko, V. & Weide, R. van der, 2006. "E&F Chaos: a user friendly software package for nonlinear economic dynamics," CeNDEF Working Papers, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance 06-15, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
    9. Apostolos Serletis & Periklis Gogas, 2000. "Purchasing power parity, nonlinearity and chaos," Applied Financial Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 10(6), pages 615-622.
    10. Weder, Mark, 1999. "Indeterminacy in the small open economy Ramsey growth model," SFB 373 Discussion Papers 1999,30, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
    11. Benigno, Gianluca & Benigno, Pierpaolo, 2008. "Exchange rate determination under interest rate rules," Journal of International Money and Finance, Elsevier, Elsevier, vol. 27(6), pages 971-993, October.
    12. De Fiore, Fiorella & Liu, Zheng, 2005. "Does trade openness matter for aggregate instability?," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 29(7), pages 1165-1192, July.
    13. Eusepi, Stefano, 2007. "Learnability and monetary policy: A global perspective," Journal of Monetary Economics, Elsevier, Elsevier, vol. 54(4), pages 1115-1131, May.
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    Cited by:
    1. Airaudo, Marco, 2012. "Endogenous Dollarization, Sovereign Risk Premia and the Taylor Principle," School of Economics Working Paper Series, LeBow College of Business, Drexel University 2012-11, LeBow College of Business, Drexel University.
    2. Airaudo, Marco & Zanna, Luis-Felipe, 2012. "Interest rate rules, endogenous cycles, and chaotic dynamics in open economies," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 36(10), pages 1566-1584.
    3. Fujisaki, Seiya, 2013. "Taylor rules and equilibrium determinacy in a two-country model with non-traded goods," Economic Modelling, Elsevier, Elsevier, vol. 35(C), pages 597-603.

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