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

Author/Editor:

Guillermo Calvo ; Carlos A. Végh Gramont

Publication Date:

March 1, 1990

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.

Series:

Working Paper No. 1990/021

Subject:

Consumption Exchange rates Inflation Interest rate policy Real interest rates

Notes:

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

English

Publication Date:

March 1, 1990

ISBN/ISSN:

9781451921427/1018-5941

Stock No:

WPIEA0211990

Pages:

32

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