Determinacy and learnability of monetary policy rules in small open economies

This paper evaluates under which conditions different Taylor-type rules lead
to determinacy and expectational stability (E-stability) of rational expecta
tions equilibrium in a simple "New Keynesian" small open economy model,
developed by Gali and Monacelli (2005). In particular, we extend Bullard
and Mitra (2002) results of determinacy and E-stability in a closed economy
to this small open economy framework. Our results highlight an important
link between the Taylor principle and both determinacy and learnability
of equilibrium in small open economies. More importantly, the degree of
openness coupled with the nature ofthe policy rule adopted by the monetary
authorities might change this link in important ways. A key finding is that,
contrary to Bullard and Mitra, expectations-based rules that involve the con
sumer price inflation and/or the nominal exchange rate limit the region of
E-stability and the Taylor Principle does not guarantee E-stability. We also
show that some forms of managed exchange rate rules can help to allevi
ate problems of both indeterminacy and expectational instability, yet these
rules might not be desirable since they can promote greater volatility in the
economy