Template-Type: ReDIF-Paper 1.0

Author-Name: Alexandra Glazova
Author-Email: GlazovaAM@cbr.ru
Author-Workplace-Name: Bank of Russia, Russian Federation

Author-Name: Maxim Nevalennyi
Author-Email: NevalennyyMYu@cbr.ru
Author-Workplace-Name: Bank of Russia, Russian Federation

Author-Name: Andrey Sinyakov
Author-Email: SinyakovAA@cbr.ru
Author-Workplace-Name: Bank of Russia, Russian Federation

Title: An Educational Model of a Small Open Economy for Monetary Policy Analysis
(with examples from Bank of Russia’s practice)

Abstract: This article presents a diagrammatic model of a small open economy. The dynamics of this
graphical model are illustrated using impulse responses from the corresponding formal semi-
structural model (Quarterly Projection Model, QPM).
This graphical model reflects the modern understanding of how a fiat monetary economy
and the current global financial system operate.1 It describes the specifics of monetary policy (MP)
responses to supply and demand shocks under inflation targeting and the importance of anchoring
inflation expectations. It explicitly considers the foreign exchange market (taking into account its
potential imperfections) and demonstrates the role of the exchange rate in the transmission of MP.
The model helps to link the global financial (credit) cycle to accumulating risks to financial stability,
which create constraints on MP (‘dilemma, not trilemma’) and require the use of additional policy
instruments.
In our view, the presented diagrammatic model is a simpler version of the graphical model
for analysing monetary policy in a small open economy than that proposed by Basu and Gopinath
(2024). Therefore, it is suitable for less experienced readers—undergraduate students. The model
not only accounts for the constraints facing monetary policy in a small open developing economy
with developed financial markets but also allows for the analysis of extreme cases, like the closure
of the financial account of the balance of payments and the associated changes in monetary policy
transmission. Consequently, the model can be used to explain the rationale behind the Bank of
Russia’s monetary policy decisions over the entire inflation targeting period. The authors provide
a detailed analysis of the Bank of Russia’s decisions from 2022 onward using the model.

Length: 125 pages
Creation-Date: 2025-08
Revision-Date:
Publication-Status:
File-URL: https://www.cbr.ru/StaticHtml/File/180507/wp_154.pdf
File-Format: Application/pdf
File-Function:
Number: wps154
Classification-JEL: E58, F38, F41, G28
Keywords: monetary policy, small open economy, foreign exchange market, inflation
targeting, monetary policy dilemma, diagrammatic general equilibrium model, Quarterly Projection
Model (QPM), Bank of Russia
Handle:RePEc:bkr:wpaper:wps154