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

Author

Listed:
  • Mr. Guillermo Calvo
  • Mr. Carlos A. Végh Gramont

Abstract

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.

Suggested Citation

  • Mr. Guillermo Calvo & Mr. Carlos A. Végh Gramont, 1990. "Interest Rate Targeting in a Small Open Economy: The Predetermined Exchange Rates Case," IMF Working Papers 1990/021, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:1990/021
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    Citations

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    Cited by:

    1. Kumhof, Michael, 2004. "Sterilization of short-term capital inflows--through lower interest rates?," Journal of International Money and Finance, Elsevier, vol. 23(7-8), pages 1209-1221.
    2. Mr. Michael Kumhof & Mr. Evan C Tanner, 2005. "Government Debt: A Key Role in Financial Intermediation," IMF Working Papers 2005/057, International Monetary Fund.
    3. Juan Carlos Echeverry G., 1996. "Short Run Savings Fluctuations And Export Shocks.Theory And Evidence For Latin-America," Borradores de Economia 3498, Banco de la Republica.
    4. Juan Carlos Echeverry, 1996. "The Fall in Colombian Savings During the 1990s. Theory and Evidence," Borradores de Economia 061, Banco de la Republica de Colombia.
    5. Vegh, Carlos, 1991. "Stopping High Inflation: An Analytical Overview," MPRA Paper 20175, University Library of Munich, Germany.
    6. Kumhof, Michael, 2000. "A quantitative exploration of the role of short-term domestic debt in balance of payments crises," Journal of International Economics, Elsevier, vol. 51(1), pages 195-215, June.
    7. Michael Kumhof, "undated". "A Quantative Exploration of the Role of Short-Term Domestic Debit in Balance of Payments Crises," Working Papers 00017, Stanford University, Department of Economics.

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    Keywords

    WP; nominal interest rate;

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