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Interest Rate Rules, Endogenous Cycles, and Chaotic Dynamics in Open Economies

  • Luis-Felipe Zanna
  • Marco Airaudo
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    We present an extensive analysis of the consequences for global equilibrium determinacy in flexible-price open economies of implementing active interest rate rules, i.e., monetary rules where the nominal interest rate responds more than proportionally to inflation. We show that conditions under which these rules generate aggregate instability by inducing liquidity traps, endogenous cycles, and chaotic dynamics depend on specific characteristics of open economies. In particular, rules that respond to expected future inflation are more prone to induce endogenous cyclical and chaotic dynamics the more open the economy to trade.

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    Paper provided by International Monetary Fund in its series IMF Working Papers with number 12/121.

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    Length: 40
    Date of creation: 01 May 2012
    Date of revision:
    Handle: RePEc:imf:imfwpa:12/121
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    1. George W. Evans & Eran Guse & Seppo Honkapohja, 2007. "Liquidity Traps, Learning and Stagnation," University of Oregon Economics Department Working Papers 2007-9, University of Oregon Economics Department, revised 05 Jun 2007.
    2. Stefano Eusepi, 2005. "Comparing forecast-based and backward-looking Taylor rules: a "global" analysis," Staff Reports 198, Federal Reserve Bank of New York.
    3. Alstadheim Ragna & Henderson Dale W., 2006. "Price-Level Determinacy, Lower Bounds on the Nominal Interest Rate, and Liquidity Traps," The B.E. Journal of Macroeconomics, De Gruyter, vol. 6(1), pages 1-27, November.
    4. Campbell Leith & Simon Wren-Lewis, 2002. "Taylor Rules in the Open Economy," Discussion Papers 0203, Exeter University, Department of Economics.
    5. Benigno, Gianluca & Benigno, Pierpaolo, 2008. "Exchange rate determination under interest rate rules," Journal of International Money and Finance, Elsevier, vol. 27(6), pages 971-993, October.
    6. Cees Diks & Cars Hommes & Valentyn Panchenko & Roy Weide, 2008. "E&F Chaos: A User Friendly Software Package for Nonlinear Economic Dynamics," Computational Economics, Society for Computational Economics, vol. 32(1), pages 221-244, September.
    7. Eusepi, Stefano, 2007. "Learnability and monetary policy: A global perspective," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1115-1131, May.
    8. Weder, Mark, 1999. "Indeterminacy in the small open economy Ramsey growth model," SFB 373 Discussion Papers 1999,30, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
    9. Thórarinn G. Pétursson, 2004. "The effects of inflation targeting on macroeconomic performance," Economics wp23_thorarinn, Department of Economics, Central bank of Iceland.
    10. Bullard, James & Singh, Aarti, 2008. "Worldwide macroeconomic stability and monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 55(Supplemen), pages S34-S47, October.
    11. Luis-Gonzalo Llosa & Vicente Tuesta, 2008. "Determinacy and Learnability of Monetary Policy Rules in Small Open Economies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(5), pages 1033-1063, 08.
    12. 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.
    13. Bask, Mikael, 2000. "A Positive Lyapunov Exponent in Swedish Exchange Rates?," Umeå Economic Studies 528, Umeå University, Department of Economics.
    14. Apostolos Serletis & Periklis Gogas, 2000. "Purchasing power parity, nonlinearity and chaos," Applied Financial Economics, Taylor & Francis Journals, vol. 10(6), pages 615-622.
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