External Debt and Taylor Rules in a Small Open Economy


We develop a dynamic stochastic general equilibrium model of a small open economy in which both price rigidity and nancial friction exist. We compare two cases featuring different interest rate rules. Both cases use the standard Taylor-type interest rate rules, but the second case also considers external debt levels. We nd that when friction in foreign borrowing is large, adding an external debt level to Taylor rules improves welfare. The welfare curve, however, exhibits a hump shape since excessive reactions to changes in external debt reduce welfare.


External debt, Taylor rules, Small open economy, DSGE, Welfare, Emerging market economies

JEL Classification

E5, F4


Shigeto KITANO
Research Institute for Economics and Business Administration
Kobe University
Rokkodai-cho, Nada-ku, Kobe
657-8501 Japan
Phone: +81-78-803-7036
FAX: +81-78-803-7059

Graduate School of Economics, Nagoya University