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Determinacy and Learnability of Monetary Policy Rules in Small Open Economies


This paper evaluates under which conditions different Taylor-type rules lead to determinacy and expectational stability (E-stability) of rational expectations equilibrium in a simple "New Keynesian" small open economy model, developed by Gali and Monacelli (2005). In particular, we extend Bullard and Mitra (2002) results of determinacy and E-stability in a closed economy to this small open economy framework. Our results highlight an important link between the Taylor principle and both determinacy and learnability of equilibrium in small open economies. More importantly, the degree of openness coupled with the nature of the policy rule adopted by the monetary authorities might change this link in important ways. A key finding is that, contrary to Bullard and Mitra, expectations-based rules that involve the consumer price inflation and/or the nominal exchange rate limit the region of E-stability and the Taylor Principle does not guarantee E-stability. We also show that some forms of managed exchange rate rules can help to alleviate problems of both indeterminacy and expectational instability, yet these rules might not be desirable since they can promote greater volatility in the economy. Copyright (c) 2008 The Ohio State University.

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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 40 (2008)
Issue (Month): 5 (08)
Pages: 1033-1063

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Handle: RePEc:mcb:jmoncb:v:40:y:2008:i:5:p:1033-1063
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  1. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  2. 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.
  3. Galí, Jordi & Monacelli, Tommaso, 2002. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," CEPR Discussion Papers 3346, C.E.P.R. Discussion Papers.
  4. 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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  9. 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.).
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  13. Bullard, James & Singh, Aarti, 2008. "Worldwide macroeconomic stability and monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 55(Supplemen), pages S34-S47, October.
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  17. Vega, Marco & Winkelried, Diego, 2004. "Inflation Targeting and Inflation Behavior: A Successful Story?," MPRA Paper 838, University Library of Munich, Germany.
  18. James B. Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis.
  19. Evans, George W. & Honkapohja, Seppo, 1999. "Learning dynamics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 7, pages 449-542 Elsevier.
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