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

_IMF Working Papers, May 1, 2012_

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**Canonical URL:** [Interest Rate Rules, Endogenous Cycles, and Chaotic Dynamics in Open Economies](https://www.imf.org/en/publications/wp/issues/2016/12/31/interest-rate-rules-endogenous-cycles-and-chaotic-dynamics-in-open-economies-25908)

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## Bibliographic details
- Authors: Luis-Felipe Zanna, Marco Airaudo
- Published: May 1, 2012
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781475503500.001

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### Summary
- Paper examines consequences for global equilibrium determinacy in flexible-price open economies from implementing active interest rate rules (nominal interest rate responds more than proportionally to inflation).
- Focus on how such rules can generate aggregate instability by inducing liquidity traps, endogenous cycles, and chaotic dynamics.
- Key finding: Rules that respond to expected future inflation are more prone to induce endogenous cyclical and chaotic dynamics the more open the economy is to trade.
- Authors: Luis-Felipe Zanna, Marco Airaudo.
- Date: May 1, 2012.
- Series: IMF Working Papers, Working Paper No. 2012/121.

### Main findings and mechanisms
- Active interest rate rules can generate multiple forms of aggregate instability:
  - Liquidity traps.
  - Endogenous cycles.
  - Chaotic dynamics.
- The incidence and nature of these instabilities depend on specific characteristics of open economies.
- Sensitivity to openness:
  - Rules that respond to expected future inflation exhibit greater propensity to induce endogenous cyclical and chaotic dynamics as trade openness increases.
- Emphasis on forward-looking policy response (response to expected future inflation) as a source of complex dynamics in open-economy settings.

### Policy implications and considerations
- Design of monetary policy rules in open economies should account for trade openness and the potential for forward-looking policy responses to create instability.
- Caution warranted when implementing active interest rate rules that place strong weight on expected future inflation in small open economies or economies with high trade openness.
- Recognition that standard prescriptions from closed-economy analyses may not carry over straightforwardly to open economies due to differing stability properties.

### Subject tags and keywords (as provided)
- Subject: Consumption, Exchange rate pass-through, Foreign exchange, Import prices, Inflation, National accounts, Prices, Real exchange rates.
- Keywords: Chaos, closed economy, Consumption, Cycles and Endogenous Fluctuations, exchange rate pass-through, Exchange rate pass-through, Global, Import prices, Inflation, interest rate, interest rate rule, Interest Rate Rules, liquidity trap, marginal utility, money balance, Multiple Equilibria, Real exchange rates, Small Open Economy, Taylor Rules, WP.

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/interest-rate-rules-endogenous-cycles-and-chaotic-dynamics-in-open-economies-25908_