Monetary Policy under Financial Exclusion

We investigate the welfare implications of alternative monetary policy rules in a small open economy with access to world capital markets. Financial market access is costly and induces an endogenous segmentation of... [ view full abstract ]

We investigate the welfare implications of alternative monetary policy rules in a small open economy with access to world capital markets. Financial market access is costly and induces an endogenous segmentation of households into non-traders who never participate and traders who only participate intermittently in asset markets. The model can reproduce standard business cycle moments of open economies. Our main policy result is that inflation targeting outperforms both the monetary targeting and Taylor rule in this environment. Given widespread evidence of endemic financial exclusion throughout the world, these results suggest caution in importing monetary policy prescriptions tailored
for developed countries into emerging economies.