Interest rate rules and welfare in open economies


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Senay O.

SCOTTISH JOURNAL OF POLITICAL ECONOMY, vol.55, no.3, pp.300-329, 2008 (SSCI) identifier identifier

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.