We extend Krawczyk and Kim (Macroecon Dyn 13(1):46-80, 1999) and apply a viability approach to a small-open economy where the exchange rate works as an additional monetary policy transmission channel. A continuous-time version of the model presented in Batini and Haldane (In: Monetary policy rules. National Bureau of Economic Research, Cambridge, pp. 157-202, 1999a) is used. The model comprises the IS equation, a supply curve and the interest parity condition. We modify the third equation to capture an impact of a domestic interest-rate hike on the speedy appreciation of local currency. We calibrate this modified model using available literature results and apply specialised software (VIKAASA) to compute the open-economy viability kernel that is a set of economic states, from which the central bank can control the economy so that it remains within a nominal constraint set. We then analyse the kernel topology and show a few stablising policies that keep the economy within the constraint set. We also discuss the robustness of such polices to shocks and parameter uncertainty and observe that viability-based policies come from models, which do not require explicit weights on the variables of interest of a central bank. We also contend that in general, viability-based policies are less likely to do damage, if the policy-maker is wrong about some aspects of the environment.
- Monetary policy
- Small-open economy