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Interest Rate Policy in a Small Open Economy: The Predetermined Exchange Rates Case

Author

Listed:
  • Guillermo A. Calvo

    (International Monetary Fund)

  • Carlos A. Végh

    (International Monetary Fund)

Abstract

An important obstacle encountered in analyzing interest rate targeting is that standard models usually lead to indeterminacy of the price level or the inflation rate. This paper develops a simple framework that avoids such problems, because the bonds whose interest rate is controlled provide liquidity services. This framework is used to examine interest rate policy in a small open economy under predetermined exchange rates. A permanent increase in the interest rate has no real effects, whereas a temporary increase in the interest rate leads to higher consumption and a current account deficit that worsens over time.

Suggested Citation

  • Guillermo A. Calvo & Carlos A. Végh, 1990. "Interest Rate Policy in a Small Open Economy: The Predetermined Exchange Rates Case," IMF Staff Papers, Palgrave Macmillan, vol. 37(4), pages 753-776, December.
  • Handle: RePEc:pal:imfstp:v:37:y:1990:i:4:p:753-776
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    References listed on IDEAS

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    1. David T. Coe, 1990. "Structural Determinants of the Natural Rate of Unemployment in Canada," IMF Staff Papers, Palgrave Macmillan, vol. 37(1), pages 94-115, March.
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    Cited by:

    1. Kumhof, Michael, 2004. "Sterilization of short-term capital inflows--through lower interest rates?," Journal of International Money and Finance, Elsevier, vol. 23(7-8), pages 1209-1221.
    2. Lopez Murphy, Ricardo & Navajas, Fernando, 1998. "Domestic savings, public savings and expenditures on consumer durable goods in Argentina," Journal of Development Economics, Elsevier, vol. 57(1), pages 97-116, October.
    3. Reinhart, Carmen M. & Vegh, Carlos A., 1995. "Nominal interest rates, consumption booms, and lack of credibility: A quantitative examination," Journal of Development Economics, Elsevier, vol. 46(2), pages 357-378, April.
    4. Vegh, Carlos, 1991. "Stopping High Inflation: An Analytical Overview," MPRA Paper 20175, University Library of Munich, Germany.
    5. Kumhof, Michael, 2000. "A quantitative exploration of the role of short-term domestic debt in balance of payments crises," Journal of International Economics, Elsevier, vol. 51(1), pages 195-215, June.
    6. Michael Kumhof & Evan C Tanner, 2005. "Government Debt; A Key Role in Financial Intermediation," IMF Working Papers 05/57, International Monetary Fund.
    7. Michael Kumhof, "undated". "A Quantative Exploration of the Role of Short-Term Domestic Debit in Balance of Payments Crises," Working Papers 00017, Stanford University, Department of Economics.
    8. Talvi, Ernesto, 1997. "Exchange rate-based stabilization with endogenous fiscal response," Journal of Development Economics, Elsevier, vol. 54(1), pages 59-75, October.
    9. Calvo, Guillermo A & Vegh, Carlos A, 1996. "Disinflation and Interest-Bearing Money," Economic Journal, Royal Economic Society, vol. 106(439), pages 1546-1563, November.
    10. Gupta, Poonam, 2005. "Aftermath of banking crises: Effects on real and monetary variables," Journal of International Money and Finance, Elsevier, vol. 24(4), pages 675-691, June.
    11. Calvo, Guillermo & Vegh, Carlos, 1991. "Exchange rate stabilization under imperfect credibility," MPRA Paper 20486, University Library of Munich, Germany.
    12. Miguel Lebre de Freitas, 2014. "On inflation and money demand in a portfolio model with shopping costs," NIPE Working Papers 13/2014, NIPE - Universidade do Minho.

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