Essays in international monetary economics

Abstract

Chapter 2 of this thesis employs a dynamic general equilibrium with Taylor wage contracts to show that the use of strict inflation targeting as a disinflation policy may result in a slump in production and a considerable increase in macroeconomic volatility. Important determinants of the magnitude of the macroeconomic oscillations in the post-disinflation state of the economy turn out to be the size of the reduction in the inflation rate and the degree of returns to labor in the production function. In the special case of constant returns, the oscillations are large and permanent. Chapter 3 of this thesis extends the above analysis to an open-economy setting demonstrating that the exchange rate can act as a stabilizer by effectively relieving wages from part of the burden of reducing the inflation rate. The more the economy is open, the smaller the magnitude of the macroeconomic oscillations will be after the disinflation policy is applied. The policy is shown to be infeasible for all practical purposes in a closed economy with constant returns to scale when the full nonlinear model is considered. Chapter 4 of this thesis employs a Markov switching framework to allow for an interesting alternative characterization of macroeconomic news effects on the foreign exchange market. The chapter finds strong evidence for the presence of nonlinear regime switching between a high-volatility and a low volatility state driven by monetary policy announcements that come as a surprise to the market. It also uncovers significant market positioning prior to the announcements, indicating a limiting of risk exposure by market participants who are unsure about the precise outcome of the policy decisions. Chapter 5 of this thesis investigates the impact of monetary shocks on the direction and the composition of international capital flows. It identifies monetary policy shocks in a structural VAR via the pure sign restrictions approach. There are two key findings. First, a US monetary easing causes net capital inflows and a worsening of the US trade balance. Second, monetary policy shocks induce a negative conditional correlation between capital flows in bonds and equity securities. Intriguingly, they cause a negative conditional correlation between equity flows and equity returns but a positive conditional correlation between bond flows and bond returns