External debt sustainability and policy rules in a small globalized economy

The paper develops a Post Keynesian macroeconomic model which discusses the conditions that lead to an external debt crisis in a small developing economy fully integrated to global goods and financial markets. The focus is on how policy rules affect the stability of the economy. Two kinds of policy rules are discussed, namely inflation target and real exchange rate target, implemented through an interest rate operation procedure (IROP). It is argued that in both cases the evolution of the real exchange rate should be closely monitored to avoid external instability. It is also suggested that a real exchange rate target may be more effective to stabilize the economy if there is a strong tendency towards the equality of the foreign and domestic real interest rates.

► The model discusses growth and stability from a Kaleckian perspective in a developing economy in which the real interest and real exchange rates are strongly affected by capital flows.
► Extends the Kaleckian model to discuss the stability of the debt to GDP ratio under different policy rules.
► Discusses why is so important to closely supervise the evolution of the real exchange rate in a developing economy.