Investment and Interest Rate Policy in the Open Economy

Figure 1: Regions of determinacy under a current-looking domestic price inflation rule

Case III is relevant for any a < 0.4716¹⁵ and condition (ii) of (32) is always satisfied.¹⁶
Thus from condition (i) of (32) first-order indeterminacy can arise provided the inflation
coefficient μ is sufficiently low. It is straightforward to show that this lower bound on μ
is decreasing with respect to a:

∂(32)(i) = - 4αΛ2(2 - Λ2)(l+ β)   < 0

∂a [(1 - 2a)α(2 - Λ2) - Λ2]²

and thus as the degree of trade openness is reduced, the higher the inflation coefficient
that is required to prevent indeterminacy.

3.2.2 Consumer Price Inflation

If consumer price inflation is the policy indicator, then the set of linearized conditions for
cross-country differences yields the five-dimensional system of the form:

¹⁵Note that this threshold level for a is independent of the degree of price stickiness (ψ). Furthermore it is
remarkably robust to variations in α and λ. For example setting λ = 4 requires a < 0.467 whereas setting
α = 0.25 requires a < 0.459.

¹⁶Given the benchmark values for β and δ, condition (ii) of (32) is always satisfied for any a ≤ 0.47 provided
α > 0.295.

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