Investment and Interest Rate Policy in the Open Economy

Table 1: Linearized system of equations

R

Notes: The index R refers to the difference between home and foreign variables e.g. C_t^R ≡

(c_t — cR) , "RRh ^f ) ≡ (C^h — C_t*^f). The index W refers to world aggregates where π^w =
^π+2∏ = ^π +2^π f and ∆e_t ≡ C_t — C_t-1. The parameters are defined as: Λ₁ ≡ (^1-ψ)ψ^1-βψ),

^λ2 ≡ 1 ^{- β}(1 ^{- δ}) and ^λ3 = [KK (2α¹-i) + ^{1 - δ}]

KZ = C ^{+ δ and} C = α [β ^{- (1 - δ})] λ-1 ^{- δ}

3 Equilibrium Determinacy

We start by examining the conditions for equilibrium determinacy when monetary policy
is characterized by a current-looking rule. First note that for a labor-only version of this
open economy model, in which production is linear in labor (α = 0), under a current-
looking rule the Taylor principle (μ > 1) prevents the emergence of real indeterminacy
for both the aggregate and difference systems.¹² As this section shows the conditions for
reduces to the relative PPP condition for consumer price inflation i.e. ΠR = ∆Ct∙

¹²For example, as shown by McKnight (2007), the Taylor principle is both a necessary and sufficient
condition for local determinacy of the aggregate system and the difference system when domestic inflation
is targeted. If CPI inflation is targeted then the Taylor principle is a necessary condition for determinacy

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