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The Monetary Transmission Mechanism For A Small Open Economy In A Monetary Union

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Executive Summary

This paper develops a stylized model of a small open economy integrated in a monetary union. Since the small country trades with countries inside and outside of the monetary union there are three economies in the model. The small open country, the economy represented by all the remaining countries that belong to the monetary union too, and the one that includes all countries that do not belong to the monetary union. The Taylor principle, which says that the interest rate rule should be such that the response of the interest rate to a unitary change in inflation should be larger than unity, is a necessary condition to have local determinacy in the model.

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