Country-Specific Risk Premium, Taylor Rules, and Exchange Rates

Annicchiarico, Barbara and Piergallini, Alessandro (2009): Country-Specific Risk Premium, Taylor Rules, and Exchange Rates.

Abstract

The adoption of a Taylor-type 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. It is demonstrated that when a risk premium on external debt affects the monetary policy transmission mechanism, 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.

• Item Type: MPRA Paper
• Language: English
• Keywords: Risk Premium on Foreign Debt; Taylor Rules; Exchange Rate Dynamics
• Subjects: F - International Economics > F3 - International Finance > F32 - Current Account Adjustment ; Short-Term Capital Movements; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; F - International Economics > F3 - International Finance > F31 - Foreign Exchange

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