Monetary Rules in Emerging Economies with Financial Market Imperfections

Abstract

The chapter considers a number of ramifications of various monetary policies for emerging market economies. The economies typically have less developed financial markets; foreign liabilities are generally denominated in foreign currency, and foreign currency is often used in some domestic transactions. It is confirmed that the conventional wisdom that the combination of financial market frictions and foreign currency denominated debt enhances the vulnerability of the economy to disturbances. The chapter finds that attempting to peg the exchange rate only serves to create more instability, as it leads to movements in interest rates that, in combination with financial factors, only serve to raise the variability of real output. Thus, this finding is consistent with Stanley Fischer's observation for the emerging market crises in Southeast Asia in 1990 that the economies that suffered greater disruptions were those that had fixed exchange rate regimes in place.

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