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Nominal Interest Rate Determination in a Semi-open Economy

Nominal Interest Rate Determination in a Semi-open Economy. By Amnat Phalapleewan Claremont Graduate University. Motivation. Increasing in regional trade and monetary cooperation.

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Nominal Interest Rate Determination in a Semi-open Economy

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  1. Nominal Interest Rate Determination in a Semi-open Economy By Amnat Phalapleewan Claremont Graduate University

  2. Motivation • Increasing in regional trade and monetary cooperation. • Unlike international financial integration, there has been only a few studies on intra-region integration in developing world. • We want to know how much financial markets in East Asia influence each other.

  3. Question • How much and what degree do the monetary policy actions among East Asian countries affect each other?

  4. Literature • International integration: Focusing on how much acountry integrate with the world financial market, for examples Chinn and Frankel (1994) and Chinn and Dooley (1995). • Intra-region integration: Focusing on regional financial integration, for examples Cheung, Chinn, and Fujii (2002, 2003), Cavoli, Rajan, and Siregar (2003), and Rajan (2003).

  5. Model Inspired by Edwards and Khan (1985) , a model incorporate the effect of capital mobility to which the degree of the domestic interest rate can be expressed as a weighted average of domestic market-clearing interest rate and foreign interest rate from UIP. equation (1) where i* is foreign interest rate adjusted for the change in exchange rate and i’ isdomestic clearing interest rate in a closed economy.

  6. From that basic concept, I modify the model as: equation (2) where ir is a regional center country and iw is the world interest rates, both are adjusted for change in exchange rate respectively.

  7. After substituting a necessary money demand function and solving for nominal interest rate determination: equation (3) Note: Assuming that the local rate cannot adjust rapidly due to sluggish in information or risk.

  8. Conclusion • Be extra careful about whether or not its own lag of interest rate should be included. • Roughly, we can detect which country pairs are likely to have close monetary tie. • No one is totally isolated.

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