## “Monetary and Fiscal Rules in an Emerging Small Open Economy”

_IMF Working Papers, January 1, 2009_

## Source details

**Canonical URL:** [“Monetary and Fiscal Rules in an Emerging Small Open Economy”](https://www.imf.org/en/publications/wp/issues/2016/12/31/monetary-and-fiscal-rules-in-an-emerging-small-open-economy-22579)

## Other formats

- [Markdown version](/en/publications/wp/issues/2016/12/31/monetary-and-fiscal-rules-in-an-emerging-small-open-economy-22579/index.md)
- [Structured JSON version](/en/publications/wp/issues/2016/12/31/monetary-and-fiscal-rules-in-an-emerging-small-open-economy-22579/index.json)
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## Bibliographic details
- Authors: Paul L Levine, Joseph G Pearlman, Nicoletta Batini
- Published: January 1, 2009
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451871692.001

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### Overview and objectives
- Develops an optimal rules-based interpretation of the "three pillars macroeconomic policy framework": a combination of a freely floating exchange rate, an explicit target for inflation, and a mechanism that ensures a stable government debt-GDP ratio around a specified long run.
- Shows how monetary-fiscal rules need to be adjusted to accommodate specific features of emerging market economies.
- Uses a two-bloc DSGE model of an emerging small open economy interacting with the rest of the world, featuring financial frictions.
- Calibrated using Chile and US data.
- Compares simple monetary and fiscal rules with the optimal Ramsey policy benchmark and with a fixed exchange rate regime.

### Model structure and calibration
- Two-bloc DSGE emerging small open economy interacting with the rest of the world.
- Key model feature: financial frictions.
- Calibration: Chile and US data.

### Policies and rules analyzed
- Monetary rules:
  - Domestic inflation targeting interest rate rule.
  - CPI inflation targeting interest rate rule (implicit partial exchange rate stabilization).
- Fiscal rule:
  - "Structural Surplus Fiscal Rule" as recently followed in Chile.
- Policy regimes compared:
  - Freely floating exchange rate with the three-pillar rules.
  - Fixed exchange rate regime.
  - Fully optimal (Ramsey) policy benchmark.

### Key findings
- Domestic inflation targeting is superior to partially or implicitly (through a CPI inflation target) or fully attempting to stabilize the exchange rate.
- Financial frictions increase the role of fiscal policy.
- Financial frictions lead to an increase in the costs associated with simple rules as opposed to the fully optimal policy.
- The three-pillar framework must be adjusted for features of emerging market economies to achieve optimal outcomes.

### Subject areas and keywords
- Subject: Consumption, Currencies, Fiscal policy, Fiscal rules, Zero lower bound
- Keywords: exchange rate, WP

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/monetary-and-fiscal-rules-in-an-emerging-small-open-economy-22579_