Money versus credit in the determination of output for small open economies

Abstract

It is well known that in a small open economy where there is perfect substitutability between domestic and foreign assets and costless portfolio adjustment, the monetary authorities, pursuing an exchange-rate target, cannot control the money supply, but can influence the balance of payments through the use of domestic credit. It has been argued that domestic credit is therefore the relevant variable in output determination as well. This paper demonstrates, however, using a “new classical†structural model, that under the conditions that render the money supply uncontrollable, neither money nor domestic credit affects output. Copyright Kluwer Academic Publishers 1991small open economy, balance of payment adjustment, money, domestic credit,