Thesis (Ph. D.)--West Virginia University, 2003. / Title from document title page. Document formatted into pages; contains vii, 105 p. : ill. Includes abstract. Includes bibliographical references (p. 98-105).

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The three chapters of this thesis address two questions. First, how are real and nominal exchange rates between different national currencies determined? Second, how does this determination influ- ence the international transmission of macroeconomic fluctuations and, especially, monetary policy disturbances? Chapter 1 comprises an empirical evaluation of long-run purchasing power parity as a theory of equilibrium nominal exchange rate determination for the post-Bretton Woods data. Structural time series methods are used to identify bivariate moving average representations of nominal exchange rates and relative goods prices and to test whether these empirical representations are consistent with the implications of purchasing power parity. Long-run purchasing power parity can be un ambiguously rejected for the G- 7 countries. There are permanent deviations from parity which account for almost all of the variance of real exchange rates, and which are driven by permanent disturbances to nominal rates which are never reflected in relative goods prices. Chapter 2 presents an empirical evaluation of the hypothesis that the global Depression of the 1930’s was attributable to international transmission of (idiosyncratic) U.S. monetary policy actions through the International Gold Exchange Standard - fixed exchange rate - regime. Specifically, the analysis evaluates whether the interwar output collapse in Canada was caused by transmitted U.S. monetary policy disturbances. A multivariate structural time series representation of the Cana dian macroeconomy is estimated which is consistent with the dynamic and long-run equilibrium properties of a Mundell- Fleming small open economy model and in which U.S. data represent the ‘rest of the world’. The empirical results show that U.S. monetary disturbances play a negligible role for both Canadian and U.S. output movements in the 1930’s. Permanent common real shocks to outputs can account for the onset, depth and duration of the Depression in both economies. There is little evidence to support a Gold-Standard transmitted global output collapse through the transmission mechanisms usually associated with purchasing power parity theories of real exchange rate determination. Chapter 3 develops an alternative theory of real and nominal exchange rate determination and of the international transmision mechanism which can account for many stylized facts regarding the empirical behaviour of real and nominal exchange rates that long-run purchasing power parity fails to explain. In a two-country, two-currency overlapping generations model, the role of optimal portfolio choices between internationally traded assets is emphasized - rather than goods market trade - as the source of currency demands. These demands, and supplied of assets generated by domestic monetary policies, determine both real and nominal exchange rates. Here, monetary policy changes can induce permanent international and intra-national reallocations through real exchange rate and real interest rate adjustments. This transmission mechanism differs markedly from that implied by purchasing power parity.

This dissertation examines the welfare effects of inflation on employment and output in three different market settings. The theoretical frameworks build on recent studies in the monetary search literature that explicitly models the microfoundations of money and study how monetary policy interacts with real variables. The first essay studies the relationship between inflation and unemployment in a general equilibrium framework where inflation has differential effects on employed and unemployed workers. The model finds that inflation can either increase or decrease employment and output, depending on goods and labor market institutions. Sales taxes, the degree of competitiveness in the goods market and imperfect indexation of unemployment insurance benefits are the major factors determining the direction of this relationship. Through a comparison of these parameters, the model predicts an inflation-unemployment relation that is qualitatively consistent with the empirical evidences. The second essay, co-authored with Liang Wang and Randall Wright, investigates the effect of inflation on people's trading behavior in the goods market. By focusing on buyers' search intensity on the extensive margin, the model unambiguously predicts a rise in inflation leads to an increase in the speed with which agents spend their money and velocity. This is consistent with the phenomenon described by the conventional "hot potato" effect of inflation. We also discuss the welfare implications of different monetary policy. In some circumstances inflating above the Friedman rule may be optimal, but the effect of inflation on output is always negative. The third essay, co-authored with Allen Head, Guido Menzio and Randall Wright, examines the effect of monetary growth on output in a general equilibrium model where price stickiness arises as an equilibrium outcome. The model makes several predictions about individual firms' price adjustment behavior that are consistent with micro data. For instance, the frequency (duration) of price changes increases (decreases) with inflation and the price change hazard declines over time. In contrast to the New Keynesian literature, price rigidities in our model does not generate monetary non-neutrality. Higher inflation reduces real output in the long run, but changes in the aggregate price level has no effect on real allocations. / Thesis (Ph.D, Economics) -- Queen's University, 2010-07-17 00:52:41.487

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Part I deals with the estimation of money demand functions. Several non-structural interpretations of the conventionally estimated functions are surveyed and discussed (Chapter 1). An application to Italian data is then presented, focusing on two such interpretations. First (Chapter 2), the role of expectations in determining money demand behaviour is assessed. Since monetary policy regimes have a direct effect on the time-series properties of interest rates, the identification of clear regime changes may provide a powerful test of forward-looking models of money demand. An expectations model is constructed, which is stable in the face of the Italian monetary policy regime change in 1970, when traditional backward-looking money demand functions show remarkable instability. Second (Chapter 3), the existence of multiple long-run relations among the variables relevant to money demand is shown to create problems for the interpretation of single-equation estimates. To obtain a satisfactory specification of the long-run relations and the short-run dynamics of the system around equilibrium, a sequential procedure is devised and applied. In Part II, the controversy between "real" and "monetary" theories of fluctuations is examined (Chapter 4). A "monetary" equilibrium model of the cycle is constructed, extending the original Lucas "island" framework to allow for a powerful role for stabilization policy. The implications of alternative monetary policy regimes are derived and tested on U.S. data, comparing two periods (1922-1940 and 1952-1968) with a different policy stance. Chapter 5 investigates the relative importance of the "money" and "credit" channels of monetary transmission for Italy in the 1982-1994 period, using a structural VAR methodology. Monetary policy is effective, though not through a "credit channel", and independent disturbances to credit supply have sizeable real effects. In Chapter 6 the focus is shifted to anticipated fiscal policy actions and their effect on consumption. A long series of pre-announced income tax changes is examined for the U.K. Consumption reacts to such fiscally-induced disposable income changes only at the implementation dates.

In the first chapter “Impact of Quantitative Easing at the Zero Lower Bound (with J. Dorich, R. Mendes)”, we introduce imperfect asset substitution and segmented asset markets, along the lines of Andres et al. (2004), in an otherwise standard small open-economy model with nominal rigidities. We estimate the model using Canadian data. We use the model to provide a quantitative assessment of the macroeconomic impact of quantitative easing (QE) when the policy rate is at its effective lower bound. In the second chapter “Impact of Forward Guidance at the Zero Lower Bound”, I consider alternative monetary policy rules under commitment in a calibrated three-equation New Keynesian model and examine the extent to which forward guidance helps to mitigate the negative real impact of the zero lower bound. The simulation results suggest that the conditional statement policy prolongs the zero lower bound duration for an additional 4 quarters and reverses half of the decline in inflation associated with the lower bound. It even generates a period of overshooting in inflation three quarters after the initial negative demand shock. Alternatively, the effect of price-level targeting as a forward guidance policy at the zero lower bound is slightly different. In the third chapter “Impact of Quantitative Easing on Household Deleveraging”, I extend the DSGE model in the first chapter with some financial frictions to explore the effects of QE on asset prices and household balance sheet. There are two effects of QE on aggregate output originated from the model. First, QE leads to a decline in term premium, which increases current consumption relative to future consumption. Second, it leads to a lower loan to collateral value ratio and a decline in external finance premium. Favorable financing condition encourages further accumulation of household debt at cheaper rates, in turn, leads to an immediate higher household debt to income ratio. In the consideration of the future withdrawal of any stimulus provided from QE, this would pose greater challenges as it implies much intensive household deleveraging process. I provide some sensitivity analysis around key parameters of the model.

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