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This thesis addresses interrelated issues that influence the implementation of monetary policy in low income countries (LICs). These include the role of inflation persistence, financial frictions and the potential impact of regime-changes or large shocks. The analysis is applied to data for the Ugandan economy. Chapter 3 extends the quantile regression approach to investigate inflation persistence in LICs. The results suggest mean-reversion for the whole sample, however, there is evidence of asymmetric mean-reversion within specific quantiles. In addition, it is noted that the level of persistence increased after 2006 and during the inflation-targeting period. The study also suggests that a measure of core inflation that is derived from wavelet techniques appears to provide a useful measure of this variable. Chapter 4 considers the role of financial frictions in Uganda. It makes use of a dynamic stochastic general equilibrium (DSGE) model that incorporates several small open-economy features. The model parameters are estimated with the aid of Bayesian techniques using quarterly macroeconomic data. The results suggest that the central bank currently responds to changes in the interest rate spread and that it may be possible to derive a more favourable sacrifice ratio by making use of a slightly more aggressive response to macroeconomic developments. Chapter 5 employs a Markov-switching DSGE model to consider the possibility of regime-switching behaviour. Two variants of regime-switching models are considered: One that incorporates regime-switching features in the monetary policy rule (only) and another that incorporates regime-switching features in both the monetary policy rule and in the volatility of the shock processes. Most of the parameters are again estimated with the aid of Bayesian techniques. The results suggest that the model parameters do not remain constant over the two regimes and the transition probabilities appear to capture important economic events. In addition, the out-of-sample evaluation suggests that the regime-switching models may provide a more accurate description of the data generating processes.

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Monetary policy changes that are unexpected by the investing public can generate great volatility and illiquidity in the equities market, and therefore may severely compromise the Federal Reserve’s ability to control the economy. Given the investing public’s power, their fear of uncertainty, and their impulsive nature to create and act upon uninformed expectations, it is imperative that the Federal Reserve uses any and all communication about monetary policy with the purpose of further advancing the their stability objectives. Initially, the Federal Reserve felt that changes in monetary policy were most effective if decided and implemented in private however over 50 years after its establishment, Ben Bernanke began to realize the power of transparency and communication. Given how recently its power was recognized and utilized, it is still a relatively new topic with various facets that have yet to be explored. This paper will carefully analyze these different facets of transparency. First it will explain why a lack of communication was originally considered to be the most effective way to implement monetary policy. Next, it will explore the relationship between the investing public’s power and their need for communication. And lastly, it will attempt estimate the best way to use communication to the Federal Reserve’s benefit, with special attention to the recent financial crisis of 2008 and how Ben Bernanke handled it. These results will reiterate the value of transparency between the Federal Reserve and the investing public about target federal funds rates and expected inflation, which will ultimately allow them to work together to achieve the same objectives.

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