Essays on Financial Intermediation and Monetary Policy in Emerging Market Economies
The dissertation examines the effects of capital inflows in models of monetary policy. In the first chapter, we develop a two-sector, two-agent New-Keynesian model of a small open economy with financial frictions and foreign currency debt in balance sheets. Focusing on an adverse foreign interest rate shock, the distributional consequences of alternative monetary-policy rules are analyzed to account for the exchange-rate stabilization motive in emerging market economies (EMEs). Under an inflation targeting regime, the depreciation of the domestic currency associated with the shock has an expansionary impact on the tradable sector via the expenditure switching channel. However, in the presence of nominal wage rigidities, the ensuing higher inflation associated with the depreciation reduces real wages, which makes households in the non-tradable sector worse off. Partially stabilizing the exchange rate, however, reverses the distributional consequences. Managed exchange rate regimes improve welfare of households in the non-tradable sector at the expense of households in the tradable sector; moreover, these policy regimes can improve aggregate welfare as long as the response to the exchange rate is not too strong. Strongly stabilizing (or fixing) the exchange rate reduces the welfare of both types of households. In an inflation-targeting regime, the use of capital controls or sterilized foreign-exchange interventions is considered as a second instrument. Solving for (Ramsey) optimal policy, we find that capital controls are effective in enhancing macroeconomic stability, while sterilized interventions are nearly ineffective in this environment.In the second chapter, we offer an evaluation of claims by policymakers in the EMEs regarding adverse effects of the capital inflows that resulted from US monetary policy during the Great Recession. Our two-country model with financial frictions allows us to consider the welfare effects of contractionary shocks to capital quality under a passive US monetary policy. We compare these effects to the effects of the same shocks when US monetary policy responds with quantitative easing. We find that emerging-market complaints regarding the real exchange rate and current account are mostly due to the shock itself, and not to the US monetary policy. US monetary policy reacting to the shock brings welfare gains for both the US and the EMEs. The gains for the US are an order of magnitude larger than the welfare gains of the EMEs, reflecting the fact that a capital quality shock that originated in the US damages the US the most.