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

Author

Listed:
  • 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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    References listed on IDEAS

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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. Juan Carlos Echeverry, 1996. "The Fall in Colombian savings during the 1990s. Theory and evidence," BORRADORES DE ECONOMIA 003593, BANCO DE LA REPÚBLICA.
    3. 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.

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