Essays on Monetary Economics and International Finance
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This thesis consists of two chapters. In the first chapter, I study optimal monetary policy rules in a general equilibrium model with financial market imperfections and uncertain business cycles. Earlier consensus view --using models with financial amplification with disturbances that have no direct effect on credit market conditions-- suggests that financial variables should not be assigned an independent role in policy making. Introducing uncertainty, time-variation in cross-sectional dispersion of firms' productive performance, alters this policy prescription. The results show that (i) optimal policy is to dampen the strength of financial amplification by responding to uncertainty (at the expense of creating a mild degree of fluctuations in inflation). (ii) a higher uncertainty makes the planner more willing to relax `financial stress' on the economy. (iii) Credit spreads are a good proxy for uncertainty, and hence, within the class of simple monetary policy rules I consider, a non-negligible interest rate response to credit spreads (32 basis points in response to a 1% change in credit spreads) -together with a strong anti-inflationary stance- achieves the highest aggregate welfare possible. In the second chapter, I study global, regional and idiosyncratic factors in driving the sovereign credit risk premium (as measured by sovereign credit default swaps) for a set of 25 emerging market economies during the last decade. The results show that (i) On average, global and regional factors account for a substantial portion of the movements in sovereign risk premium (of 63% and 21%, respectively). (ii) there exists noticeable heterogeneity in the contribution of factors across the emerging markets. (iii) The (extracted) global factor is best reflected by the VIX (investors' risk sentiment) among the financial market indicators considered. (iv) There are regime changes in the relation between the global factor and the financial market indicators.