Author： Huybens E. Smith B.D.
Publisher： Academic Press
ISSN： 0022-0531
Source： Journal of Economic Theory, Vol.81, Iss.2, 1998-08, pp. : 353-400
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Abstract
We consider a small open economy with a costly state verification problem and binding reserve requirements. The presence of these frictions leads to the existence of two steady states with credit rationing. An increase in the money growth rate, the world interest rate or reserve requirements raises (lowers) GDP in the high (low) activity steady state. However, sufficiently large increases in money growth or the world interest rate can transform the high activity steady state from a sink to a source. The model also delivers prescriptions for restoring the stability of this steady state in such an eventuality.
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