| This dissertation develops three exchange rate models that explicitly incorporate a Taylor Rule type monetary policy in order to study its implications on exchange rate dynamics. Since the seminal work of Taylor (1993), the Taylor Rule has become a new standard in the literatures on exchange rates as well as monetary policy. The results reported in this dissertation imply that the Taylor Rule may be very useful in understanding exchange rate dynamics better.; My first two essays attempt to improve on the performance of the existing techniques for estimating the half-life of Purchasing Power Parity (PPP) deviations. The first essay, "Half-Life Estimation under the Taylor Rule," addresses two perennial problems in the current PPP literature, namely, unreasonably long half-life estimates of PPP deviations (PPP Puzzle; Rogoff, 1996) and extremely wide confidence intervals for half-life point estimates (Murray and Papell, 2002).; In the second essay, "Half-Life Estimation under the Taylor Rule: Two Goods Model," I estimate and compare half-lives of PPP deviations for PPI- and CPI-based real exchange rates. As an extension of my first essay (single good model), we employ a GMM system method in a two-goods model, where the central bank attempts to keep general inflation (e.g., GDP deflator inflation) in check. In a similar framework that employs a money demand function instead of the Taylor Rule, Kim (2004) reported much shorter half-life point estimates for the non-service consumption deflators than those for service consumption deflators, though with quite wide confidence intervals. In contrast, I find that half-life estimates were about the same irrespective of the choice of aggregate price indexes, which is consistent with many other studies that reported only moderate or no difference.; Finally, the third essay, "Local-Currency Pricing, Technology Diffusion, and the Optimal Interest Rate Rule," studies optimal monetary policy and its implications on exchange rate regimes in a dynamic stochastic general equilibrium model that features sticky-price, local-currency pricing, and technology diffusion. The main findings of this essay are twofold. First, in response to a favorable real shock, central banks may raise nominal interest rates despite price-stickiness and local-currency pricing, which seems to be consistent with empirical evidence of rising nominal interest rates during economic boom. Second, central banks respond identically to technology shocks that occur in tradables sectors so that optimal monetary policies do not require any exchange rate change. (Abstract shortened by UMI.)... |
