Interest-rate rules and transitional dynamics in an endogenously growing open economy

Abstract

This paper sets up an endogenous growth model of an open economy in which the monetary authority implements a gradualist interest-rate rule with targets for both inflation and economic growth. We show that, under a passive rule, a monetary equilibrium exists and is unique. Moreover, the equilibrium is locally determinate. By contrast, an active rule implies either two equilibria, one high-growth and one low-growth, or none. In the case of two equilibria, the high-growth equilibrium is locally determinate, while the low-growth equilibrium is a source. Besides, the stabilization and growth effects of alternative target policies are also explored in this study. Moreover, in departing from the existing literature, we turn to focus on the analysis of transition with a particular emphasis on the case of imperfect credibility.