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Country-Specific Risk Premium, Taylor Rules, and Exchange Rates

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  • Annicchiarico, Barbara
  • Piergallini, Alessandro

Abstract

The adoption of a Taylor-type monetary policy rule and an inflation target for emerging market economies that choose a flexible exchange rate regime is often advocated. This paper investigates the issue of exchange rate determination when interest-rate feedback rules are implemented in a continuous-time optimizing model of a small open economy facing an imperfect global capital market. It is demonstrated that when a risk premium on external debt affects the monetary policy transmission mechanism, the Taylor principle is not a necessary condition for determinacy of equilibrium. On the other hand, it is shown that exchange rate dynamics critically depends on whether monetary policy is active or passive.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 13553.

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Date of creation: 2009
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Handle: RePEc:pra:mprapa:13553

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Keywords: Risk Premium on Foreign Debt; Taylor Rules; Exchange Rate Dynamics;

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  1. Robert G. King, 2000. "The new IS-LM model : language, logic, and limits," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 45-103.
  2. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
  3. Stanley Fischer, 2001. "Exchange Rate Regimes: Is the Bipolar View Correct?," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 3-24, Spring.
  4. Bennett McCallum, . "Multiple-Solution Indeterminacies in Monetary Policy Analysis," GSIA Working Papers 2003-E77, Carnegie Mellon University, Tepper School of Business.
  5. Bianca De Paoli, 2009. "Monetary Policy under Alternative Asset Market Structures: The Case of a Small Open Economy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(7), pages 1301-1330, October.
  6. Jagdeep S. Bhandari & Nadeem Ul Haque & Stephen J. Turnovsky, 1990. "Growth, External Debt, and Sovereign Risk in a Small Open Economy," IMF Staff Papers, Palgrave Macmillan, vol. 37(2), pages 388-417, June.
  7. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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