Interest rate rules and welfare in open economies

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    Abstract

    This paper analyses the welfare performance of a set of five alternative interest rate rules in an open economy stochastic dynamic general equilibrium model with nominal rigidities. A rule with a lagged interest rate term, high feedback on inflation and low feedback on output is found to yield the highest welfare for a small open economy. This result is robust across different degrees of openness, different sources of home and foreign shocks, alternative foreign monetary rules and different specifications for price-setting behaviour. The same rule emerges as both the Nash and cooperative equilibria in a two-country version of the model.

    Original languageEnglish
    Pages (from-to)300-329
    Number of pages30
    JournalScottish Journal of Political Economy
    Volume55
    Issue number3
    Early online date2 Jun 2008
    DOIs
    Publication statusPublished - Jul 2008

    Keywords

    • Monetary-policy rules
    • Exchange-rate
    • Central banks
    • Business cycles
    • Euro area
    • Models
    • Macroeconomics
    • Framework
    • Prices
    • Welfare
    • Interest rate rules
    • Second order approximation

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