Abstract:
Stability results for an open economy DSGE adapted to an emerging market (SOEME) with a dualistic
structure have the same structure as in the original model, but those derived for the simulated version
turn out to impose no restriction on the coefficient of inflation, but rather a threshold on the coefficient
of the output gap. Other rigidities, lags and some degree of backward looking behavior in the simulated
SOEME model arising from its calibration to an emerging market, may be helping provide a nominal
anchor. Estimation of a Taylor rule for India, simulations in the SOEME model itself and a variant with
government debt, confirm the analytical result. Implications are, first, optimization can be as effective
as following a monetary policy rule. Second, knowledge of the specific rigidities in an economy can give
useful inputs for the design of policy—their effect on stability should be more carefully researched.
