In this paper, we reconsider the question how monetary policy influences exchange rate dynamics. To this end, a vector autoregressive (VAR) model is combined with a two-country dynamic stochastic general equilibrium (DSGE) model. Instead of focusing exclusively on how monetary policy shocks affect the level of exchange rates, we also analyze how they impact exchange rate volatility. Since exchange rate volatility is not observed, we estimate it alongside the remaining quantities in the model. Our findings can be summarized as follows. Contractionary monetary policy shocks lead to an appreciation of the home currency, with exchange rate responses in the short-run typically undershooting their long-run level of appreciation. They also lead to an increase in exchange rate volatility. Historical and forecast error variance decompositions indicate that monetary policy shocks explain an appreciable amount of exchange rate movements and the corresponding volatility. / Series: Department of Economics Working Paper Series

Cette thèse présente trois modèles théoriques et empiriques de la Zone Euro, mettant en perspective l'influence de l'aversion au risque et de la monnaie sur différentes variables. Ces modèles d'équilibre général intertemporels et stochastiques (DSGE) s'inscrivent dans le cadre de la théorie des Nouveaux Keynésiens. Dans un premier modèle de base, nous montrons que l'aversion au risque influence la production, contribuant à sa baisse, notamment en période de crise. Pendant ces périodes de crise (Système Monétaire Européen, 1992; Internet, 2000; Subprimes, 2007), l'aversion au risque impacte significativement la détention de monnaie réelle. Dans un second modèle, dans lequel la monnaie est considérée comme un facteur de production, cette dernière n'a pas d'implication significative sur les dynamiques des autres variables. L'hypothèse de rendements d'échelle constants est par là même rejetée. Dans un troisième modèle, en utilisant une fonction d'utilité non-séparable entre la consommation et les encaisses réelles, nous montrons que le rôle de ces dernières sur la production dépend du degré d'aversion au risque des agents, devenant significatif lorsque celui-ci est deux fois plus élevé que la normale. Enfin, nous testons et comparons ce modèle avec le modèle de base pendant les trois périodes susmentionnées. La monnaie explique alors une partie significative des variations de la production pendant ces crises. De plus, notre analyse montre qu'un modèle non-séparable entre la consommation et les encaisses réelles a de meilleures capacités prédictives qu'un modèle séparable en période de crise.

<p>Two DSGE models are calibrated and simulated to investigate how the role of monetarypolicy differs between a closed and an open economy. The central bank conducts monetary policy according to a Taylor (1993) rule, reacting to inflation- and output deviations. Prices are sticky and there are habit components which slow down adjustment of consumption and exports. The models are subjected to shocks in the interest rate, inflation, technology and consumption. In most of the cases the shocks have a bigger and quicker affect on output and employment in the open economy. In connection with positive consumption- and interest rate shocks inflation is big and negative at first but gets positive already two quarters after the shock, due to effects in the exchange rate channel. In closed and open economies, a stronger reaction to output, than in the standard Taylor (1993) rule, decreases welfare losses dramatically.</p>

Two DSGE models are calibrated and simulated to investigate how the role of monetarypolicy differs between a closed and an open economy. The central bank conducts monetary policy according to a Taylor (1993) rule, reacting to inflation- and output deviations. Prices are sticky and there are habit components which slow down adjustment of consumption and exports. The models are subjected to shocks in the interest rate, inflation, technology and consumption. In most of the cases the shocks have a bigger and quicker affect on output and employment in the open economy. In connection with positive consumption- and interest rate shocks inflation is big and negative at first but gets positive already two quarters after the shock, due to effects in the exchange rate channel. In closed and open economies, a stronger reaction to output, than in the standard Taylor (1993) rule, decreases welfare losses dramatically.

<p>This dissertation is the collection of three essays aimed to evaluate the empirical performance of dynamic stochastic general equilibrium (DSGE) models in explaining the behavior of macroeconomic dynamics in emerging countries. </p><p>Chapter 1, which is joint work with M. Uribe and R. Pancrazzi, investigates the hypothesis that a real business cycles model driven by permanent and transitory productivity shocks can explain well observed business-cycle fluctuations in emerging countries. The model is estimated using more than a century of Argentine data. </p><p>In Chapter 2, a comprehensive real DSGE model of an emerging country is estimated using Bayesian techniques, expanding the data set used in Chapter 1. The goal is to characterize the relative relevance of ten different business cycles' drivers: three sectorial technology shocks, embodied and disembodied non-stationary technology, terms of trade, the world interest rate, trade policy, government expenditures and the country premium. </p><p>Finally, Chapter 3 estimates (using Mexican data) a DSGE model of an emerging country containing many frictions, as has been recently argued, that impose non-trivial constraints for monetary-policy design. In particular, the framework features a sectorial decomposition of the productive sector, intermediate inputs, imperfect pass-through, endogenous premium to finance capital accumulation, a liability-dollarization problem, currency substitution, price and wage rigidities, and dynamics driven by eleven shocks.</p> / Dissertation

<p>This dissertation computes the optimal monetary and fiscal policy for small open and emerging economies in an estimated medium-scale model. The model departs from the conventional approach as it encompasses all the major nominal and real rigidities normally found in the literature in a single framework. After estimating the model using Bayesian techniques for one small open economy and one emerging economy, the Ramsey solution for the optimal monetary and fiscal policy is computed. Results show that foreign shocks have a strong influence in the dynamics of emerging economies, when compared to the designed optimal policy for a developed small open economy. For both economies, inflation is low, but very volatile, while taxes follow the traditional results in the literature with high taxes over labor income and low taxes for capital income.</p> / Dissertation

<p>This dissertation is a collection of essays with the main objective of estimate and understand macroeconomic behavior of emerging countries by the lenses of modern tools in general equilibrium modeling.</p><p>In the first chapter, I study whether structural parameters of Small Open Economy Real Business Cycle models are constant when applied to Emerging Markets data. Using data from Argentina, I estimate a small open economy model with trend shocks and working capital constraints, augmented with time varying parameters. I find that so called ``structural" parameters suffer substantial changes in the period 1983-2008. Structural instabilities arise from both technological and financial sources. Given these findings, I inquire which are the features of the data that parameter drifts capture. I review emerging markets facts and find parameter instabilities play a key role in addressing for the variability observed in the data.</p><p>In the second chapter, I study policy changes in emerging countries. Motivated by the repeated stabilization programs implemented by emerging economies during the last 30 years, I develop a dynamic stochastic general equilibrium model with Markov-Switching to study fiscal and monetary policies in emerging economies. I estimate the model for Mexico and find strong evidence of policy changes. Two Regimes are identified. The Active Monetary Policy Regime (AMP), in which monetary and fiscal policies respond to inflation and government debt, respectively; and the Active Fiscal Policy Regime (AFP), in which fiscal policy does not respond to government debt and monetary policy does not respond to inflation. AMP holds during short periods of time after macroeconomic crises during the 80s and 90s, and for a long period after 2002. The rest of the periods, AFP is in effect. I find that switches from AFP to AMP have strong stabilization effects at the cost of high output losses. Moreover, credibility in the persistence of the regime change is key to assess the effectiveness of the stabilization program.</p> / Dissertation

<p>This dissertation presents two essays on Markov-Switching dynamic stochastic general equilibrium models.</p><p>The first essay is "Perturbation Methods for Markov-Switching Models," which is co-authored with Juan Rubio-Ramirez, Dan Waggoner, and Tao Zha. This essay develops an perturbation-based approach to solving dynamic stochastic general equilibrium models with Markov-Switching, which implies that parameters governing policies or the environment evolve over time in a discrete manner. Our approach has the advantages that it introduces regime switching from first principles, allows for higher-order approximations, shows non-certainty equivalence of first-order approximations, and allows checking the solution for determinacy. We explain the model setup, introduce an iterative procedure to solve the model, and illustrate it using a real business cycle example.</p><p>The second essay considers a model with financial frictions and studies the role of expectations and unconventional monetary policy during financial crises. During a financial crisis, the financial sector has</p><p>reduced ability to provide credit to productive firms, and the central bank may help lessen the magnitude of the downturn by using unconventional monetary policy to inject liquidity into credit markets. The model allows agents in the economy to expect policy changes by allowing parameters to change according to a Markov process, so agents have expectations about the probability of the central bank intervening during a crisis, and also have expectations about the central bank's exit strategy post-crisis. </p><p>Using this Markov Regime Switching specification, the paper addresses three issues. First, it considers the effects of different exit strategies, and shows that, after a crisis, if the central bank sells off its accumulated assets too quickly, the economy can experience a double-dip recession. Second, it analyzes the effects of expectations of intervention policy on pre-crisis behavior. In particular, if the central bank commits to always intervening during crises, there is a loss of output in pre-crisis times relative to if the central bank commits to never intervening. Finally, it considers the welfare implications of committing to intervening during crises, and shows that committing can raise or lower welfare depending upon the exit strategy used, and that committing before a crisis can be welfare decreasing but then welfare increasing once a crisis occurs.</p> / Dissertation

<p>This dissertation aims to introduce a new sequential Monte Carlo (SMC) based estimation framework for structural models used in macroeconomics and industrial organization. Current Markov chain Monte Carlo (MCMC) estimation methods for structural models suffer from slow Markov chain convergence, which means parameter and state spaces of interest might not be properly explored unless huge numbers of samples are simulated. This could lead to insurmountable computational burdens for the estimation of those structural models that are expensive to solve. In contrast, SMC methods rely on the principle of sequential importance sampling to jointly evolve simulated particles, thus bypassing the dependence on Markov chain convergence altogether. This dissertation will explore the feasibility and the potential benefits to estimating structural models using SMC based methods.</p><p> Chapter 1 casts the structural estimation problem in the form of inference of hidden Markov models and demonstrates with a simple growth model.</p><p> Chapter 2 presents the key ingredients, both conceptual and theoretical, to successful SMC parameter estimation strategies in the context of structural economic models.</p><p> Chapter 3, based on Chen, Petralia and Lopes (2010), develops SMC estimation methods for dynamic stochastic general equilibrium (DSGE) models. SMC algorithms allow a simultaneous filtering of time-varying state vectors and estimation of fixed parameters. We first establish empirical feasibility of the full SMC approach by comparing estimation results from both MCMC batch estimation and SMC on-line estimation on a simple neoclassical growth model. We then estimate a large scale DSGE model for the Euro area developed in Smets and Wouters (2003) with a full SMC approach, and revisit the on-going debate between the merits of reduced form and structural models in the macroeconomics context by performing sequential model assessment between the DSGE model and various VAR/BVAR models.</p><p> Chapter 4 proposes an SMC estimation procedure and show that it readily applies to the estimation of dynamic discrete games with serially correlated endogenous state variables. I apply this estimation procedure to a dynamic oligopolistic game of entry using data from the generic pharmaceutical industry and demonstrate that the proposed SMC method can potentially better explore the parameter posterior space while being more computationally efficient than MCMC estimation. In addition, I show how the unobserved endogenous cost paths could be recovered using particle smoothing, both with and without parameter uncertainty. Parameter estimates obtained using this SMC based method largely concur with earlier findings that spillover effect from market entry is significant and plays an important role in the generic drug industry, but that it might not be as high as previously thought when full model uncertainty is taken into account during estimation.</p> / Dissertation

This thesis analyses financial stability in eight members of the Executives’ Meeting of East Asia-Pacific Central Banks (EMEAP) economies. One of the factors that may increase financial imbalances (and hence it affects financial stability of an economy) is the accumulated outstanding debt of the economic agents. For example, the corporate sector’s outstanding debt can negatively affect activity of lenders and hence the capabilities of the economy. Since banks are important financial intermediaries in most financial systems, the financial status of banking sector is also important to analyse financial stability of a country. Macroeconomic conditions and financial system structure are some of the important factors that can affect financial conditions (financial soundness) of banks and hence the banking sector. Financial soundness of banks can secure the stability of the financial system. Chapter 2 shows that financial imbalances that arise from accumulated outstanding debt within the corporate sector have a negative effect on the technical capabilities (total factor productivity) of the economy. Therefore, monetary authority (central bank) should control over the debt level. To address this, chapter 2 focuses on the design of monetary policy rule for a small open economy in the context of a Dynamic Stochastic General Equilibrium (DSGE) model. This model is extended to show the effects of financial imbalances on the economy. Real exchange rate is another important factor that affects the firm’s real marginal cost, aggregate supply and aggregate demand as discussed in this chapter. The derived optimal monetary policy rule indicates that the monetary authority responds to financial imbalances through output gap when financial imbalances exist due to accumulated outstanding debt. Moreover, the optimal policy rule shows that the response of the monetary authority to exchange rate movements is indirect, through the domestic inflation and output gap. Chapter 3 describes the effect of the financial system structure on financial stability through investigating the financial soundness of the banking sector. Bank financial soundness is the measure of the stability of the financial system and is defined by return on assets, equity capital-asset ratio and return volatility. The first two items increase financial soundness, whereas return volatility decreases financial soundness of a bank. The structure of the financial system is described as market-based or bank-based. Given interrelations between financial sectors and between economies of the EMEAP countries, chapter 3 uses the global (infinite dimensional) vector autoregressive (VAR) model that has been proposed recently to estimate the generalised impulse responses of financial stability measure. Results show that the market-based financial system can increase financial stability through increasing financial soundness of the banking system. Chapter 4 uses nonperforming loans (NPLs) (as one of the main factors behind Asian financial crisis in 1997/8) to analyse financial soundness of banks. NPLs determine loans default rates that decreases banks’ financial soundness. Chapter 4 tests the resistance of the banking system of the EMEAP countries to large macroeconomic shocks (stresses) in a stress-test framework, computing frequency distributions of default rates in three main macroeconomic scenarios (baseline model, stressed real GDP growth and stressed real interest rate). Default rate indicates the possible loss of banks and hence it is an indicator of credit risk which weakens banks’ financial strength. The stress-test indicates that stressing real GDP growth with negative extreme shocks leads to an increase in frequency of higher default rates (in comparison with the baseline model), whereas positive shock to real interest rate may secure financial stability through increasing the frequency of lower default rates and decreasing frequency of higher default rate.