Monetary Policy in Emerging Market Economies
This dissertation studies monetary policy in emerging market economies and addresses three important questions from both a normative and positive perspective. Chapter 1 studies how central banks should react when capital flows are volatile. The analytical framework is a Markov-switching dynamic stochastic general equilibrium model that features time-varying external volatility. Computational results suggest that central banks can improve welfare and maintain macroeconomic stability if they allow the response coefficients in the interest rate rule to vary according to the external volatility regime. The optimal simple rule suggests that central banks should target inflation when external volatility is low and stabilize exchange rates when it is high, which is akin to the “leaning against the wind” approach adopted by some emerging market central banks. Chapter 2 studies the optimal inflation target for an emerging market central bank. Existing research on advanced economies shows that targeting core inflation enables monetary policy to maximize welfare. This result is examined in the context of emerging market economies, where a large proportion of households are credit constrained and the share of food expenditures in total consumption expenditures is high. Results obtained using an open economy model with incomplete financial markets indicate that headline inflation targeting improves welfare outcomes. The optimal price index includes a positive weight on food prices but assigns zero weight to import prices. Chapter 3 studies the inter-sectoral distributional effects of monetary policy in emerging market economies. Emerging market economies with fast-growing tradable sectors often face appreciation pressure, and they tend to use monetary policy to postpone currency appreciation and maintain export competitiveness. A two-sector, heterogeneous-agent model with incomplete financial markets is developed to study the inter-sectoral distributional effects of such policy choices. Relative to inflation targeting, exchange rate management can temporarily benefit households in the tradable sector in high-growth periods, but these households are worse off under the welfare criterion due to higher future consumption volatility. Capital controls and fixed exchange rate regimes amplify those distributional effects.
Exchange Rate; International Finance; Monetary Policy; Economics; Capital Flows; Central Banking; Emerging Market Economies
Prasad, Eswar Shanker
Bianchi, Francesco; Mertens, Karel
Ph. D., Economics
Doctor of Philosophy
dissertation or thesis