Essays on international economics, monetary rules and multiple equilibria

Monetary business cycles model that display multiple equilibria as a consequence of government policies or rules may be used to the development of a rich theory of macroeconomic policy. They can be used to find policies that eliminate the possibility of multiple equilibria. The reason is that policies or rules that generate multiple equilibria may induce aggregate instability by embarking the economy on fluctuations that are not only determined by fundamentals but also by people\u27s self-fulfilling expectations. The characterization of these monetary and fiscal rules or policies has been extensively accomplished for closed economies. However the study of these rules in open economies, and in particular the small open economy, is a new and growing field. This dissertation intends to contribute to this field. Specifically it studies conditions under which interest-rate feedback rules and Purchasing Power Parity (PPP) rules may lead to real indeterminacy in the small open economy. In Chapter 2 we study Taylor rules or interest rate-feedback rules. In this chapter it is shown that conditions under which these rules lead to real indeterminacy depend not only on the type of monetary rule, active or passive, but also on the degree of openness of the economy and on the measure of inflation to which the central bank responds. Chapter 3 is motivated by the observation that countries that have been hit by a balance of payments crisis tend to increase their interest rates to fight against currency depreciation and stabilize the economy. This chapter analyzes interest rate rules in which the government increases the interest rate in response to higher nominal depreciation rates. It is shown that in general multiple equilibria are possible depending on the type of interest rate rule and on the type of fiscal policy. However rules whereby the interest rate is linked to the current depreciation rate may cause real indeterminacy regardless of the type of fiscal policy. Chapter 4 studies PPP rules. It shows that the characterization of the equilibrium for these rules not only depends on the sensitivity of the rules but also on some structural parameters such as the degree of openness of the economy, the degrees of monopolistic competition and price stickiness in the non-traded sector among others. Finally Chapter 5 estimates an interest rate rule for Colombia using monthly data from 1991:7 to 2003:2. The estimates suggest that the Central Bank has followed a contemporaneous and active interest rate rule with respect to inflation and that it includes either the real appreciation rate or the nominal depreciation rate as an intermediate target