Monetary Growth Rules in an Emerging Open Economy

We develop a small open economy model interacting with a rest-of-the-world bloc, containing several emerging economies' features: Calvo-type nominal frictions in prices and wages, financial frictions in the form of limited asset markets participation (LAMP), as well as both formal and informal sectors. In addition, we introduce incomplete exchange rate pass-through via a combination of producer and local currency pricing for exports, as well commodity-dependence in the form of an oil export sector. We contrast the stability and determinacy properties of money growth and standard Taylor-type interest rate rules, showing that monetary rules are stable regardless of the level of asset market participation, i.e. they avoid the inversion of the Taylor principle. We estimate our 2-bloc model using data for Iran and the USA employing Bayesian methods and we study the empirical relevance of the frictions in our model. Our results reveal important propagation channels active in emerging economies and that taking these into account is essential for policymaking decisions. Indeed, shocks to the economy are amplified by the presence of LAMP, while trade autarky further intensifies the effects of financial frictions. On the other hand, the informal sector acts as buffer to several shocks, lowering the variability of aggregate and formal fluctuations.