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

By Guillermo Calvo, Carlos A. Végh Gramont

March 1, 1990

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Guillermo Calvo, and Carlos A. Végh Gramont Interest Rate Targeting in a Small Open Economy: The Predetermined Exchange Rates Case, (USA: International Monetary Fund, 1990) accessed November 23, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

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.

Subject: Consumption, Exchange rates, Inflation, Interest rate policy, Real interest rates

Keywords: Nominal interest rate, WP

Publication Details

Pages:

32
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 1990/021
Stock No:

WPIEA0211990
ISBN:

9781451921427
ISSN:

1018-5941

Notes

Also published in Staff Papers, Vol. 37, No. 4, December 1990.

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