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This thesis examines the interaction between monetary policy, inflation and asset prices. The role of asset prices in the transmission mechanism of monetary policy via consumption wealth effects and investment balance sheet effects is receiving a growing degree of attention nowadays. Financial asset prices respond quickly to new information about monetary policy shifts, while the transmission of policy actions to output and inflation exhibits significant lags. Therefore, it is important to examine the feedback between interest rates and asset prices, since it will provide important insights for central bankers and investors alike. This area of the literature draws from both the monetary economics and financial economics disciplines and has become quite important given the new challenges for monetary policyrnakers in the context of fundamental changes in the underlying financial and macroeconomic framework. In this respect, we are interested in three main issues: first, to investigate the impact of the, nowadays prevalent, inflation targeting monetary policy regime on average inflation and the related inflationary uncertainty (Chapter 2); second, to establish quantitatively the existence of a transmission link from changes in the monetary policy stance to the stock market (Chapter 1); third, to examine the monetary policy reaction to asset price fluctuations (Chapters 3-5). Chapter 2 looks at the significant changes that occurred in the inflation process over the 1990s using British data. We show that post-targeting, inflation is lower, less persistent and less volatile. In chapter 3, we use data from the UK and the US and find that lower expected inflation allows monetary policy to relax by decreasing short-term interest rates. In chapter 1, international evidence suggests that decreases in interest rates exert a significantly positive impact on stock prices in the majority of the countries under investigation. Hence, the empirical evidence in chapters 1-3 is consistent with the scenario underlying the so-called 'new environment' hypothesis. Inflation targets were successful in anchoring inflation expectations and subsequently boosting stock prices due to lower interest rates. In chapters 3-5 we focus on the role of asset prices for monetary policy formulation. We present empirical (chapter 3), theoretical (chapter 4), and simulation n(chapter 5) evidence indicating that monetary policy has responded and should, in principle, respond to asset price fluctuations. Particularly, in chapter 3 we augment the standard forward-looking Taylor rule with the change in asset prices (house prices, stock prices) and find that there is a positive and statistically significant weight attached to asset price fluctuations in both the UK and the US. The estimates suggest that policyrnakers in the US are more concerned about stock market developments, while in the UK about house market developments. In chapter 4, we utilise a structural backward-looking economic model, augmented for the effect of asset prices on aggregate demand, that allows us to derive the optimal interest rate rule via dynamic minimisation of the central bank's loss function. We show that under certain assumptions about the asset price evolution, monetary policy should react to asset price misalignments from their fundamental value. Finally, in chapter 5 we simulate a forward-looking model to examine the impact on macroeconomic volatility from reacting, or not, to asset price misalignments. We find that a policy reaction that is aggressive with respect to inflation, and mild (but not zero) with respect to asset price misalignments is able to promote overall macroeconomic stability.

The developments in asset markets have influenced researchersto focus on the interaction between monetary policy and the financial system. In Chapter I we provide an overview of the role of the financial system for the whole economy. We show the importance of this sector in transmitting the monetary policy actions. The aim of this research is twofold; firstly we want to investigate how important the amount of credit for the whole economy is. To accomplish this objective, in Chapter 2 we make use of the VAR technique to study the monetary transmission mechanism. In particular we are interested in explaining why previous empirical research has found that prices show an increase after monetary tightening. We investigate how an unanticipated movement in the risk free interest rate affects all those variables responsible for the transmission of a monetary shock. Our results suggest that the immediate increase in prices is not due to some form of econometric misspecification, but rather, to the change in the composition of firms' source of finance. Prices rise because the need for external funds increases thus firms' costs of production increase. Another important issue that we want to tackle is the contribution of external finance to the 1990 economic recession. In Chapter 3 we show that the increased level of indebtedness as one of the forces at the root of the economic downturn. We argue that the crisis could be explained on the basis of Minsky's financial instability hypothesis. In the remaining part of this research we tackle the second aim of this research: we focus our attention on the link between asset prices and monetary policy. Asset prices, in fact, can give an indication of future consumers' and firms' decisions on spending and, therefore, might be indicators of future economic activity. Wealth deriving from gains in these markets tends t o increase the level of consumption and investment. A t the same time, sharp movements in asset prices could signal imbalances in the economy; developments of this kind can threaten financial stability. In Chapter 4 we argue there might be a trade-off between financial stability and monetary stability when these are the main objectives of the monetary authorities. First we explore the possibility that the demand equation is affected positively by changes in asset prices, secondly empirical findings suggest that for the period 1992: 10-2003: 1 monetary policy in the UK can be better represented by a rule which takes into consideration movements in house prices and stock prices. The empirical evidence provided in Chapter 4 brings us in Chapter 5 to construct a macroeconomic model where the asset prices enter indirectly into the Central Bank's loss function. We model the aggregate demand of the economy so that output is determined, among other variables, by the wealth effect. The optimal interest rate rule is obtained by optimising intertemporally a loss function that includes inflation and output variance. We find that the optimal policy in the presence of wealth effects not only depends upon inflation and output but also it depends on financial imbalances, as represented by asset price misalignments from fundamentals. The response to asset price deviations from fundamentals becomes more aggressive as wealth effects build up, while the reaction to inflation and the output gap becomes less pronounced.

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Economic theory typically assumes that monetary policy is set by a single policy-maker. However, the reality of monetary policy decision-making is very different. Monetary Policy Committees (MPCs) are responsible for setting the short-term interest rate in most countries across the world, and up until very recently, economists paid little serious attention to this fact. In light of this finding, this thesis (i) addresses the current dissonance between the theory and reality of monetary policy decision making and (ii) assesses the empirical evidence on monetary policy committee voting, with emphasis on the voting behaviour of Bank of England MPC members. The thesis contains four core chapters. In Chapter 3 I extend the game-theoretic literature on jury decision making to include the case of a monetary policy committee faced with making a binary choice under simple majority rule. I gauge the extent to which decision outcomes are a function of the amount of effort put into the decisions by individual members when paying attention is not costless. The game builds on Mukhopadhaya (2003), and is of the 'contribution' variety proposed by Rasmusen (2001).In Chapter 4 I present a boundedly-rational model of how monetary policy committees are able to reach decisions on the interest-rate. I draw upon Morris DeGroot's (1974) characterization of consensus formation in groups and DeMarzo, Vayanos and Zweibel's (2003) notion of persuasion bias. Monetary policy committees are shown to reach agreement even when the views its members are initially diverse. The model potentially explains the stylised facts of how members of the United States Federal Open Market Committee, European Central Bank Governing Council and Bank of England Monetary Policy Committee reach a decision on the interest-rate. Chapters 5 and 6 constitute empirical analyses of MPC voting behaviour, and investigate the voting behaviour of members of the Bank of England Monetary Policy Committee over the first five years of its being. This encompasses the entire spell for which the MPC was chaired by Sir Edward George. Using voting data obtained from Minutes of meetings, I show that as a group, internally appointed MPC members (insiders) on average prefer lower interest rates than external appointees (outsiders). Ordered logit analysis demonstrates that insiders and outsiders are motivated by different concerns when setting interest rates. Asymmetric policy preferences exist for the two groups. Insiders are found to dissents significantly less often than outsiders, with the majority of dissents cast by the former group being on the side of tightness. For outsiders, the reverse is shown to be true, with the majority of dissents being for looser policy.

Our target is to objectively quantify important aspects of emerging economies’ financial markets and deliver value adding actionable recommendations that can be used by a wide spectrum of end-users like academics, policy makers and real life investors. We create two quantitative models that capture the dynamics of global Emerging Market currencies and sovereign debt ratings. We build on the extensive literature on Emerging Market crises and introduce a number of methodological and conceptual innovations. A wide range of market stylized facts and practical and intuitive limitations dictate the way we progress with our research, from considering and selecting dependent and explanatory variables to the way we apply and interpret the model results. We first estimate a parsimonious panel specification that models and forecasts Emerging Market currency dynamics and produces trade signals for investing in one-month forward exchange rates. The second instrument models and forecasts credit ratings assigned by two of the leading rating agencies to Emerging Market sovereigns. The specifications we select are tested on the basis of their statistical and forecasting performance which is found to be solid and unbiased. The currency model is further tested based on its ability to generate profit making trading portfolios. The ratings model is also assessed based on its forecasts for forthcoming sovereign rating actions. We proceed to apply both models on real time data and compare the results from blindly following the model recommendations to a situation where an investor filters these results by superimposing his market awareness and subjective judgement. Our findings suggest that the tools developed here can reliably be integrated in an investor’s decision process. The events of late 2010 suggest that many of the ideas presented in our work can be implemented to Developed Markets and be expected to produce interesting and usable results.

Cette thèse analyse les déterminants et les conséquences des cycles financiers, afin d’en fournir des recommandations de politique économique. Ce terme relativement nouveau invoque aussi bien le comportement pro-cyclique des agents financiers que le cycle de différentes variables, tels que le crédit, et les marchés boursiers et immobiliers. Cette définition permet de dissocier le cycle financier national de l’international. Dans un premier temps, cette thèse propose de nouveaux déterminants aux cycles financiers nationaux. Je mets en avant le rôle primordial de la structure de la dette en termes de maturité. A travers une analyse flux-stock, je démontre que la dynamique de la dette suit généralement une tendance sous-optimale, tantôt trop axée sur les dettes de court-terme, tantôt trop tournée vers le long-terme. Cette thèse propose aussi un deuxième nouveau déterminant de ces cycles financiers, à savoir l’évolution des inégalités. J’en tire trois prédictions théoriques, qui se vérifient dans mon analyse économétrique : i) la hausse des inégalités conduit à une augmentation du crédit aux ménages au niveau agrégé ; ii) l’essentiel de ce lien de causalité est tiré par le rôle clé des classes moyennes ; iii) ce lien de causalité positif existe si et seulement si le pays est suffisamment développé. Dans un deuxième temps, j’analyse les conséquences du cycle financier global, conduit principalement par la politique monétaire américaine. Je démontre que l’exposition domestique aux forces étrangères, en particulier via la présence de banques globales, réduit l’autonomie de la politique monétaire, mais que ce cycle ne change pas la nature du triangle d’incompatibilité de Mundell. / This thesis focuses on the determinants and policy implications of financial cycles. This term is fairly new and in line with the conventional logic of business cycles. It involves the boom-bust cycle in credit, equity and housing markets as well as the procyclical behavior of agents. This general definition allows us to distinguish the national financial cycles from the international ones exclusively through the level of integration to the international financial system, with close transmission channels. On the one hand, this brings up questions about their various determinants. I consider debt maturity structure as potential determinant. By using a stock-flow analysis, I find that the mix of these debts chosen by the agent follows a suboptimal path. Financial crises could be triggered by excessive reliance on either short-term or long-term debt. This thesis also exhibits the role of income inequality as key factor of these national financial cycles. Three main predictions are supported by an empirical analysis: i), an increase in inequality leads to an expansion on household credit at the aggregate level; ii) the bulk of the positive impact of inequality on household credit is driven by middle classes; iii) the positive causal link from inequality to household credit exists if and only if the country is sufficiently developed. On the other hand, I will also debate the consequences and policy implications of the global financial cycle, led primarily by US monetary policy. This exposure to foreign forces reduces the scope of domestic monetary policy, but the Mundellian trilemma does not morph into a dilemma.

This thesis provides a contribution to the analysis of the link between monetary policy and financial markets. It does so by combining elements from the finance and economics literature and developing areas of intersection which, to some extent, have been evolving in a rather autonomous manner. The thesis takes an empirical perspective and examines three main issues. The first regards the modelling of the short-term interest rate where models are presented that integrate finance contributions with the literature on monetary policy rules. The chapter concludes that there are non-linearities in the short-rate process and these are related to macroeconomic factors in a way consistent with a monetary policy rule. A second essay deals with the effect of monetary policy announcements, improving on previous contributions by extending the investigation to a broader set of instruments and using multivariate models of volatility to capture in a better way the complex interactions between monetary policy and financial markets. The issue of the endogeneity of monetary policy is also a main concern in the final essay of the thesis which examines the contribution of monetary policy shocks in explaining fluctuations in real stock prices in the G7. In this chapter, it is argued that previous approaches may suffer from an omitted variables problem. By including a minimum set of variables both for identifying monetary policy shocks and explaining real stock prices, the study concludes that monetary policy may make a stronger contribution to stock price fluctuations than what is usually found in similar studies.

Malgré le consensus qui prévaut sur les effets de la politique monétaire, à court et moyen termes sur l’économie réelle, et à long terme sur l’inflation, le poids relatif des canaux de transmission de politique monétaire reste en débat. Aujourd’hui les derniers résultats de la littérature sur la politique monétaire et les évolutions importantes constatées dans la structure financière et économique des pays du monde, conduisent à de nouvelles idées et interrogations sur l’importance du rôle de la politique monétaire. L’ouverture croissante des économies nationales pose en effet de nouveaux défis aux mécanismes de transmission de politique monétaire existants. Cependant, les chercheurs ont encore peu exploité cette nouvelle dimension et la littérature actuelle n’explique qu’une partie de la relation mondialisation/inflation. Cette thèse vise à apporter une contribution à ce débat. En débutant par une analyse des mécanismes de transmission monétaire, des canaux et des décalages correspondants, nous développons un modèle théorique qui explique les évolutions et les défis de la politique monétaire dans un contexte de mondialisation. Nous utilisons ensuite une base de données concernant un large échantillon de pays pour calculer dans un premier temps la production potentielle et l’écart de production pour l’ensemble de l’échantillon. Puis, dans un second temps, à l’aide d’estimations en données de panel fondées sur une équation de la courbe de Philips, nous étudions les impacts de la mondialisation sur l’inflation pour l’ensemble des économies du panel mais aussi pour des sous-ensembles régionaux. / Despite the prevalent consensus on the short to medium-run effects of monetary policy shocks on the real economy and long-run effects on inflation; the relative importance of the channels of monetary transmission mechanism (MTM) still remains open to debate. In this regard, recent findings of the monetary literature and the important developments in the economic and financial structure of the economies on the whole invoke new insights and important questions on the relevancy of monetary policy. The new era of increased openness has also started posing new challenges to the existing monetary transmission mechanism and the policy effects thereof. However, this area has yet not been explored on merit by the researchers, and the existing literature explains only a small part of this globalization –inflation puzzle. Therefore, this thesis aims to make a contribution to this debate. Starting with the analysis of monetary transmission the corresponding channels and the lags we develop a theoretical model to explain the developments and challenges to the monetary policy in the current scenario of increased globalization. The succeeding section deals with the data of a large set of economies, where in the first instance we compute the potential output and subsequently the output gap for the whole sample. Going ahead we conduct panel estimation using Phillips curve equation for our sample to investigate the globalization impacts on the economies on the whole and in parts based on the regional and economic groups.

This thesis consists of three essays on optimal monetary policy. In the first essay I study time-consistent monetary policy in an small open economy model with incomplete financial markets. I demonstrate the existence of two discretionary equilibria. The model is capable of explaining periods of different exchange rate volatilities as well as the transition between those regimes. Following a shock the economy can be stabilised either `quickly' or `slow', where both dynamic paths satisfy the conditions of optimality and time-consistency. I also show that a policy of partially targeting the exchange rate results in far worse welfare outcomes relative to a strict inflation targeting policy. In the second essay, I analyse how a policy maker can avoid expectation traps and coordination failures. Using a framework developed by Schaumburg and Tambalotti (2007) and Debortoli and Nunes (2010) in which a policy maker may or may not default on past promises I show that already mild degrees of precommitment are sufficient to generate uniqueness of the Pareto-preferred equilibrium. In the last chapter, I examine optimal monetary policy from an empirical perspective. I estimate a simple small open economy model separately for a policy maker acting under commitment and discretion and find that the data favours the commitment approach. Furthermore, the data suggest that the Bank of Canada did not target the nominal exchange rate in the inspected time period.