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Investment and Interest Rate Policy in the Open Economy

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Author Info
Stephen McKnight () (Department of Economics, University of Reading)

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Abstract

This paper presents a two-country sticky-price model that allows for capital and investment spending. It analyzes the conditions for equilibrium determinacy under alternative interest-rate rules that react to either domestic or consumer price inflation. It is shown that in the presence of investment, real indeterminacy is considerably easier to obtain once trade openness is permitted. Consequently we argue that sufficiently open economies should adopt a backward-looking rule and sufficiently closed economies should employ a current-looking rule, in order to minimize policy induced aggregate instability.

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Publisher Info
Paper provided by Henley Business School, Reading University in its series Economic Analysis Research Group Working Papers with number earg-wp2007-11.

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Length: 33 pages
Date of creation: Oct 2007
Date of revision:
Handle: RePEc:rdg:eargwp:earg-wp2007-11

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Related research
Keywords: Real indeterminacy; Open economy macroeconomics; Interest rate rules; Monetary Policy;

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Find related papers by JEL classification:
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates
E53 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Deposit Insurance
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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  1. Kurozumi, Takushi, 2006. "Determinacy and expectational stability of equilibrium in a monetary sticky-price model with Taylor rule," Journal of Monetary Economics, Elsevier, vol. 53(4), pages 827-846, May. [Downloadable!] (restricted)
  2. Bernanke, Ben S & Woodford, Michael, 1997. "Inflation Forecasts and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 653-84, November.
    Other versions:
  3. Nicoletta Batini & Paul Levine & Joseph Pearlman, 2004. "Indeterminacy with inflation-forecast-based rules in a two-bloc model," International Finance Discussion Papers 797, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
    Other versions:
  4. Stefano Eusepi & Jess Benhabib, 2005. "The Design of Monetary and Fiscal Policy: A Global Perspective," 2005 Meeting Papers 926, Society for Economic Dynamics. [Downloadable!]
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  5. Dupor, Bill, 2001. "Investment and Interest Rate Policy," Journal of Economic Theory, Elsevier, vol. 98(1), pages 85-113, May. [Downloadable!] (restricted)
  6. Carlstrom, Charles T. & Fuerst, Timothy S., 2001. "Timing and real indeterminacy in monetary models," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 285-298, April. [Downloadable!] (restricted)
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  7. Charles T. Carlstrom & Timothy S. Fuerst, 2003. "Investment and interest rate policy: a discrete time analysis," Working Paper 0320, Federal Reserve Bank of Cleveland. [Downloadable!]
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  8. Stephen McKnight, 2007. "Real Indeterminacy and the Timing of Money in Open Economies," Economics & Management Discussion Papers em-dp2007-46, Henley Business School, Reading University. [Downloadable!]
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  9. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February. [Downloadable!] (restricted)
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  10. Sveen, Tommy & Weinke, Lutz, 2005. "New perspectives on capital, sticky prices, and the Taylor principle," Journal of Economic Theory, Elsevier, vol. 123(1), pages 21-39, July. [Downloadable!] (restricted)
  11. Luis Gonzalo Llosa & Vicente Tuesta, 2006. "Determinacy and Learnability of Monetary Policy Rules in Small Open Economies," RES Working Papers 4479, Inter-American Development Bank, Research Department. [Downloadable!]
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  12. 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. [Downloadable!] (restricted)
  13. William Kerr & Robert G. King, 1996. "Limits on interest rate rules in the IS model," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 47-75. [Downloadable!]
  14. Kurozumi, Takushi & Van Zandweghe, Willem, 2008. "Investment, interest rate policy, and equilibrium stability," Journal of Economic Dynamics and Control, Elsevier, vol. 32(5), pages 1489-1516, May. [Downloadable!] (restricted)
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