Barbara Annicchiarico; Alessandro Piergallini :
056_DP74 Country-Specific Risk Premium, Taylor Rules, and Exchange Rates
JEL Classification:
F31; F32; E52
Abstract:
The adoption of a monetary policy rule and an inflation target for emerging market economies that choose a flexible exchange rate regime is often advocated. This paper investigates the issue of exchange rate determination when interest-rate feedback rules are implemented in a continuous-time optimizing model of a small open economy facing an imperfect global capital market. In this framework, the Taylor principle is not a necessary condition for determinacy of equilibrium. On the other hand, it is shown that exchange rate dynamics critically depends on whether monetary policy is active or passive.
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