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Monetary policy in a developing economy with external debt: Theory and empirics

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  • Mark Assibey-Yeboah
  • Mohammed Mohsin

Abstract

Using annual data from four open economies (Thailand, Indonesia, Mexico, and Chile), and estimating correlations and generalized impulse responses within the traditional vector autoregressive (VAR) analysis, we find that inflation, both in the short and long run, is negatively correlated with consumption, investment, and the stock of foreign debt. We propose an optimizing model of an open economy with outstanding foreign debt and borrowing constraint that could explain these empirics. In this economy, risk premium depends on creditworthiness measured by debt--income ratio. Firms operate under costly investment, and all transactions involving consumption and investment are subject to cash-in-advance (CIA) constraints.

Suggested Citation

  • Mark Assibey-Yeboah & Mohammed Mohsin, 2012. "Monetary policy in a developing economy with external debt: Theory and empirics," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 21(5), pages 705-724, October.
  • Handle: RePEc:taf:jitecd:v:21:y:2012:i:5:p:705-724
    DOI: 10.1080/09638199.2010.535213
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    References listed on IDEAS

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    1. Jonas D. M. Fisher, 2001. "A real explanation for heterogeneous investment dynamics," Working Paper Series WP-01-14, Federal Reserve Bank of Chicago.
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    Cited by:

    1. Assibey-Yeboah, Mark & Mohsin, Mohammed, 2014. "The real effects of inflation in a developing economy with external debt and sovereign risk," The North American Journal of Economics and Finance, Elsevier, vol. 30(C), pages 40-55.

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