Simple Rules for the Open Economy: Evaluating Alternative Proposals

The paper evaluates some proposals for macroeconomic stabilization in an open economy, which take the form of simple rules. The first rule assigns monetary policy to inflation control and does not require fiscal intervention. The second rule adds fiscal control of a foreign wealth target to the first assignment. In the third proposal the fiscal instrument is assigned to the internal objective and monetary policy controls foreign wealth. The fourth rule differs from the third in that monetary policy stabilizes the exchange rate at its target zone level. Our analysis shows that control rules for open economy models (which include the current account) might be unstable because of the cumulation of debt service obligations, and that the inclusion of fiscal feedback can prevent such instability.