Mavromatis, Konstantinos (2012) Essays on exchange rates and optimal monetary policy for open economies. PhD thesis, University of Warwick.

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Abstract

The thesis consists of three chapters of self-contained empirical and theoretical studies.
In Chapter 1, I examine whether the Balassa-Samuelson effect is indeed the reason
behind the behaviour of the currencies of transition economies. So far, in the literature,
transition Economies appear to be subject to the Balassa-Samuelson effect. This implies
that their currencies experience a prolonged appreciation in real terms as their convergence
goes on. However, in the current literature, the effects of the capital account have
not been analyzed extensively. In this paper I show that the capital account, rather
than productivity, is a key determinant of the appreciation of the currencies of transition
economies. I find that a long-run relationship exists between the real exchange rate,
productivity, the real interest rate differential and the capital account. Moreover, those
variables are found to cointegrate in a nonlinear fashion according to a smooth transition
autoregressive model. This implies that a multivariate smooth transition error correction
model is the appropriate model to describe their short-run and long-run dynamics.
In Chapter 2, I examine the importance of a real exchange rate target in the monetary
policy of a central bank. I address that question both empirically and theoretically. Using
monthly data I estimate of a structural VAR model for the Eurozone providing evidence
in favour of real exchange rate targeting. I examine this case theoretically using a twocountry
DSGE model; I find that when the home central bank includes a real exchange
rate target in its interest rate rule, it achieves lower welfare losses compared to the Taylor
rule. Contrary to similar papers, I compute the optimized coefficients in the interest rate
rules considered. I show that the benefits from real exchange rate targeting at home rise
as persistence in inflation and output increases. In the robustness analysis I show that a
rise in the fraction of backward looking consumers affects negatively the performance of
the real exchange rate targeting rule and positively that of the Taylor rule. Asymmetries
in the degree of rule-of-thumb behavior in consumption have important effects, as regards
the performance of a real exchange rate targeting rule. The performance of both rules is
not sensitive to variations in the degree of backward looking price setting behavior .
In Chapter 3, I show, using both empirical and theoretical analysis, that changes in
monetary policy in one country can have important effects on other economies. My
new empirical evidence shows that changes in the monetary policy behaviour of the
Fed since the start of the Euro, well captured by a Markov-switching Taylor rule, have
had significant effects on the behaviour of inflation and output in the Eurozone even
though ECB’s monetary policy is found to be fairly stable. Using a two-country DSGE
model, I examine this case theoretically; monetary policy in one of the countries (labelled
foreign) switches regimes according to a Markov-switching process and this has nonnegligible
effects in the other (home) country. Switching by the foreign central bank
renders commitment to a time invariant interest rate rule suboptimal for the home central
bank. This is because home agents expectations change as foreign monetary policy changes which affects the dynamics of home inflation and output. Optimal policy in the
home country instead reacts to the regime of the foreign monetary policy and so implies
a time-varying reaction of the home Central Bank. Following this time-varying optimal
policy at home eliminates the effects in the home country of foreign regime shifts, and
also reduces dramatically the effects in the foreign country. Therefore, changes in foreign
monetary regimes should not be neglected in considering monetary policy at home.

Item Type:	Thesis or Dissertation (PhD)
Subjects:	H Social Sciences > HB Economic Theory
Library of Congress Subject Headings (LCSH):	Free enterprise, Foreign exchange, Monetary policy
Official Date:	April 2012
Dates:	Date Event April 2012 Submitted
Institution:	University of Warwick
Theses Department:	Department of Economics
Thesis Type:	PhD
Publication Status:	Unpublished
Supervisor(s)/Advisor:	Taylor, Mark P., 1958- ; Boero, Gianna
Extent:	viii, 139 leaves : charts
Language:	eng

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