Optimal Monetary Policy with an Interest-Equalization Tax in a Small Open Economy

Abstract

Uncovered interest rate parity (UIP) severely constrains the ability of monetary policy to achieve domestic stabilization goals. In a model which does not include an imported imput, control of a wage indexation parameter enhances the effectiveness of monetary policy considerably. Here, wage indexation is shown to be less effective when used with monetary policy in a framework that does include an imported intermediate goods. Monetary policy effectiveness is, however, significantly enhanced by incorporating an interest-equalization tax stabilizer into the framework. [E52]