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Interest Rate Targeting in a Small Open Economy; The Predetermined Exchange Rates Case

Author

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  • Guillermo Calvo
  • Carlos A. Végh Gramont

Abstract

An important hurdle in analyzing interest rate targeting is that standard models usually lead to price level or inflation rate indeterminacy. This paper develops a simple framework in which such problems do not arise because the bonds whose interest rate is controlled provide liquidity services. This framework is used to examine interest rate targeting in a small open economy under predetermined exchange rates. A permanent increase in the interest rate has no real effects. In contrast, a temporary increase in the interest rate leads to higher consumption and to a current account deficit that worsens over time.

Suggested Citation

  • Guillermo Calvo & Carlos A. Végh Gramont, 1990. "Interest Rate Targeting in a Small Open Economy; The Predetermined Exchange Rates Case," IMF Working Papers 90/21, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:90/21
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    Cited by:

    1. Juan Carlos Echeverry G., 1996. "Short Run Savings Fluctuations And Export Shocks.Theory And Evidence For Latin-America," BORRADORES DE ECONOMIA 003498, BANCO DE LA REPÚBLICA.
    2. 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.
    3. Juan Carlos Echeverry, 1996. "The Fall in Colombian savings during the 1990s. Theory and evidence," BORRADORES DE ECONOMIA 003593, BANCO DE LA REPÚBLICA.

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