Interest-rate rules and transitional dynamics in an endogenously growing open economy Shu-hua Chen a , Ming-fu Shaw b , Ching-chong Lai b,c, * , Juin-jen Chang c a Department of International Trade, Shih Chien University, Taipei 104, Taiwan b Department of Economics, National Chengchi University, Taipei 116, Taiwan c Institute of Economics, Academia Sinica, Nankang, Taipei 115, Taiwan Abstract This paper sets up an endogenous growth model of an open economy in which the monetary authority implements a gradualist interest-rate rule with targets for both inflation and economic growth. We show that, under a passive rule, a monetary equilibrium exists and is unique. Moreover, the equilibrium is lo- cally determinate. By contrast, an active rule implies either two equilibria, one high-growth and one low- growth, or none. In the case of two equilibria, the high-growth equilibrium is locally determinate, while the low-growth equilibrium is a source. Besides, the stabilization and growth effects of alternative target policies are also explored in this study. Moreover, in departing from the existing literature, we turn to focus on the analysis of transition with a particular emphasis on the case of imperfect credibility. Ó 2007 Published by Elsevier Ltd. JEL classification: F43; E52; O4 Keywords: Interest-rate rules; Gradualism; Endogenous growth 1. Introduction The interest of economists in interest-rate rules has been sparked by early studies by Sargent and Wallace (1975) and McCallum (1981) and revived by Taylor (1993) in the light of * Corresponding author. Institute of Economics, Academia Sinica, Nankang, Taipei 115, Taiwan. Tel.: þ886 2 27822791x645; fax: þ886 2 27853946. E-mail address: cclai@econ.sinica.edu.tw (C.-c. Lai). 0261-5606/$ - see front matter Ó 2007 Published by Elsevier Ltd. doi:10.1016/j.jimonfin.2007.09.009 Available online at www.sciencedirect.com Journal of International Money and Finance 27 (2008) 54e75 www.elsevier.com/locate/jimf