This paper develops a variant of the IMF’s Global Economic Model suitable to analyze macroeconomic dynamics in open economies, and uses it to assess the effectiveness of Taylor rules and inflation-forecast-based (IFB) rules in stabilizing variability in output and inflation. Our findings suggest that a simple IFB rule that does not rely upon any direct estimates of the equilibrium real interest rate and places a relatively high weight on the inflation forecast may perform better in small open economies than conventional Taylor rules.

JEL classification: C51, E31, E52

Keywords: Monetary policy, Taylor rule, Flexible exchange rates, Transition countries, Emerging markets