Monetary Policy Rules for Financially Vulnerable EconomieEd

One distinguishable characteristic of emerging economies is that they are not financially robust. These economies are incapable to smooth out large external shocks as sudden capital outflows imply large and abrupt swings in the real exchange rate. Using a small open economy model this paper examines alternative monetary policy rules for economies with different degrees of liability dollarization. The paper answers the question of how efficient is to use inflation targeting under high liability dollarization. Our findings suggest that it might be optimal to follow a non-linear policy rule that defends the real exchange rate in a financially vulnerable economy.