Domestic interest rates and monetary policy in small open economies with fixed and flexible exchange rates

Author(s): Worrell, DeLisle (1995)

Created 22 Jul, 1995
Categories Working Papers Delisle Worrell
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This paper examines the domestic interest rates and monetary policy in small open economies with fixed and flexible exchange rates. Although the Mundell/Fleming theorem has strongly influenced thinking about macroeconomic policy, few open economies have stuck to its precepts, because imperfections in international capital markets (due to transactions costs, information costs, exchange rate uncertainty and other factors) make for less-than perfect capital mobility. By comparing domestic interest rate movements with the international interest rate parity condition and domestic monetary adjustment, we infer the degree of monetary autonomy for a sample of small open economies in the Caribbean. Monetary policy may be least effective as a tool for balance of payments stabilization in precisely those circumstances where it is most urgently needed for that purpose.

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