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Monetary Rules in Emerging Economies with Financial Market Imperfections

In: International Dimensions of Monetary Policy

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  • Nicoletta Batini
  • Paul Levine
  • Joseph Pearlman

Abstract

We build a two-bloc emerging market - rest of the world model. The emerging market bloc incorporates partial transactions and liability dollarization, as well as financial frictions including a ‘financial accelerator’, where capital financing is partly or totally in foreign currency as in Gertler et al. (2003) and Gilchrist (2003)). Simulations of the model under various ‘operational’ monetary policy rules derived assuming that the central bank maximizes households’ utility point to important results. First, we reaffirm the finding in the literature that financial frictions, especially when coupled with liability dollarization, severely increase the costs of a fixed exchange rate regime. By contrast, transactions dollarization has only a small impact on the choice of the monetary regime. Second, central banks in emerging economies with these frictions should not explicitly target the exchange rate; nor should they implicitly do so by choosing a CPI rather than domestic price inflation target. Third, with dollarization and frictions, the zero lower bound constraint on the nominal interest rate makes simple Taylor-type rules perform much worse in terms of stabilization performance than fully optimal monetary policy.
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Suggested Citation

  • Nicoletta Batini & Paul Levine & Joseph Pearlman, 2007. "Monetary Rules in Emerging Economies with Financial Market Imperfections," NBER Chapters, in: International Dimensions of Monetary Policy, pages 251-311, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberch:0519
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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