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Essays on international finance and monetary economics

Castillo Martinez, Laura (2019) Essays on international finance and monetary economics. PhD thesis, London School of Economics and Political Science.

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This thesis examines three dimensions of monetary policy: its implementation through exchange rates, its role in price level determination and its interaction with fiscal policy. Following a sudden stop, real exchange rates can adjust through a nominal exchange rate depreciation, lower domestic prices, or a combination of both. Chapter 1 makes four contributions to understand how the type of adjustment shapes the response of macroeconomic variables, in particular productivity, to such an episode. First, it documents that aggregate TFP systematically collapses after a sudden stop under a flexible exchange rate arrangement while it moderately improves within a currency union. Second, using firm-level data for two sudden stops in Spain, it shows that the difference in the productivity response is largely driven by firm entry and exit dynamics. Third, it proposes a small open economy DSGE framework with firm selection into production and endogenous markups to explain the empirical findings. Fourth, it uses a quantitative version of the model to revisit the relative performance of exchange rate policies after a sudden stop. Different theories of the price level are too often presented in terms of opposing camps and conflicting policymakers. As a result, most economists resort to undergraduate monetarist insights to explain inflation, even though for the most part they do not apply to modern advanced economies. Chapter 2 investigates how central banks control inflation in terms of one unified theory that allows for different policy choices by the central bank. Chapter 3 examines the incentives that shape monetary policy in the context of dual mandates. I present a simple model of optimal monetary policy based on a multitask principal-agent problem framework with two agents. I show there is risk of excessive hawkishness if the compensation scheme is not appropriately designed.

Item Type: Thesis (PhD)
Additional Information: © 2019 Laura Castillo Martinez
Library of Congress subject classification: H Social Sciences > HB Economic Theory
H Social Sciences > HG Finance
Sets: Departments > Economics
Supervisor: Tenreyro, Silvana

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