Interest Rate Rules, Endogenous Cycles, and Chaotic Dynamics in Open Economies

42 Pages Posted: 9 Aug 2012

See all articles by Marco Airaudo

Marco Airaudo

Drexel University

Luis-Felipe Zanna

International Monetary Fund (IMF)

Date Written: May 2012

Abstract

We present an extensive analysis of the consequences for global equilibrium determinacy in flexible-price open economies of implementing active interest rate rules, i.e., monetary rules where the nominal interest rate responds more than proportionally to inflation. We show that conditions under which these rules generate aggregate instability by inducing liquidity traps, endogenous cycles, and chaotic dynamics depend on specific characteristics of open economies. In particular, rules that respond to expected future inflation are more prone to induce endogenous cyclical and chaotic dynamics the more open the economy to trade.

Keywords: Small Open Economy, Interest Rate Rules, Taylor Rules, Multiple Equilibria, Chaos, Cycles And Endogenous Fluctuations, Economic Models, Interest Rates, Real Effective Exchange Rates

JEL Classification: E32, E52, F41

Suggested Citation

Airaudo, Marco and Zanna, Luis-Felipe, Interest Rate Rules, Endogenous Cycles, and Chaotic Dynamics in Open Economies (May 2012). IMF Working Paper No. 12/121, Available at SSRN: https://ssrn.com/abstract=2127016

Marco Airaudo

Drexel University ( email )

3141 Chestnut St
Philadelphia, PA 19104
United States

Luis-Felipe Zanna

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States