Optimal monetary policies and business cycles in small open economies

This dissertation studies monetary policies and business cycles in small open economies. Chapter 2 examines optimal currency basket regimes for East Asia. I argue that existing literature has ignored an important characteristic of East Asia, i.e., most of the international trade in East Asia involves transactions for which prices are quoted in the U.S. dollar, a phenomenon known as dollar invoicing. I develop a dynamic stochastic general equilibrium (DSGE) model to investigate how dollar invoicing affects optimal currency basket regimes for East Asia. I show that it implies that the dollar should receive a smaller weight than suggested by bilateral trade shares between East Asia and the United States.; Chapter 3 explores the welfare implications of a small country's exchange rate regime, for the small country itself, as well as for a large country, the currency of which the small country potentially pegs to. A DSGE model is developed for the analysis. Floating exchange rate regimes are modeled as interest rate rules, with different feedback coefficients on inflation and output. I show that compared to a fixed exchange rate regime, both countries will be worse off if the small country adopts an interest rate rule with a large feedback coefficient on output and a small feedback coefficient on inflation. I also show that it is important for the small country not to respond to output fluctuations in its interest rate rule, as it will generate costly fluctuations of inflation.; In Chapter 4, a small open economy DSGE model is developed to assess the importance of terms of trade and world interest rate shocks in the business cycles of small open economies. The structural parameters of the model are estimated using a Bayesian structural estimation method. The main findings are world interest rate shocks are important driving forces of business cycles in small open economies, while terms of trade shocks are not.