We analyze economic dynamics and monetary policy response in a Small Open Economy model when the exchange rate is determined in a monopolistic competitive exchange rate market. In the model, international financiers act as intermediaries in bonds trading and their risk-bearing capacity determines how exchange rate react to capital flows. We use the model to reproduce the persistent depreciation observed in indebted countries and the appreciation enhanced by capital inflows. We then analyze the role of monetary policy in stabilizing the economy. Optimal policy, by responding to exchange rate movements, neutralizes some of the real effects of exchange rate misalignment and better performs at stabilizing the economy in a risky environment.
En salle C216