Abstract
Many of the advances in monetary policy analysis over the past two decades have been developed from the perspective of a large open economy. The early theoretical work on the New Keynesian model frequently ignored exchange rates, financial capital flows, and trade flows. This neglect carried over into the first generation of DSGE models that were taken to the data and used for policy experiments. When open-economy versions of New Keynesian models were developed, they generally assumed perfect capital mobility and uncovered interest parity. While these assumptions allowed the models to address some issues relevant for open economies, they were often not well suited for investigating policy issues in small open economies where financial markets were not fully integrated into world capital markets, and where domestic financial markets were underdeveloped. Standard models also restricted attention to interest rates as the sole instrument of monetary policy, ignoring the role that exchange rate controls, monetary aggregates, and required reserve ratios play as policy instruments in many emerging-market economies.
Authors
- Donald Coletti
- Michael B. Devereux
- Andrew Levin
- Carl E. Walsh
- John C. Williams