Interest rate rules and multiple equilibria in the small open economy

by Luis-Felipe Zanna

"In a small open economy model with traded and non-traded goods this paper characterizes conditions under which interest rate rules induce aggregate instability by generating multiple equilibria. These conditions depend not only on how aggressively the rule responds to inflation, but also on the measure of inflation to which the government responds, on the degree of openness of the economy and on the degree of exchange rate pass-through. As an important policy implication, this paper finds that to avoid aggregate instability in the economy the government should implement an aggressive...