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External Debt and Taylor Rules in a Small Open Economy

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  • Shigeto Kitano
  • Kenya Takaku

Abstract

We develop a dynamic stochastic general equilibrium model of a small open economy in which both price rigidity and financial friction exist. We compare two cases featuring different interest rate rules. Both cases use the standard Taylor-type interest rate rules, but the second case also considers external debt levels. We find that when friction in foreign borrowing is large, adding an external debt level to Taylor rules improves welfare. The welfare curve, however, exhibits a hump shape since excessive reactions to changes in external debt reduce welfare.
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  • Shigeto Kitano & Kenya Takaku, 2016. "External Debt and Taylor Rules in a Small Open Economy," Pacific Economic Review, Wiley Blackwell, vol. 21(5), pages 541-559, December.
    • Handle: RePEc:bla:pacecr:v:21:y:2016:i:5:p:541-559
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    More about this item

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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