Essays in open economy macroeconomics

The first essay proposes a model to investigate the effects of monetary policy in an emerging market economy that experiences a sudden stop of capital inflows. I show that the higher the elasticity of foreign demand, the lower the contraction in output - leading, at the extreme, to the possibility of an expansion. Interest rate rules reacting to inflation and output stabilize the output more than a fixed exchange rate regime. Low credibility and the risk of loose policy imply increased trade-offs, stronger contraction of the economy, and higher interest rates.; The second essay builds on the framework presented in the first essay to consider how monetary policy should react to a sudden stop of capital inflows. Optimal monetary policy boosts export revenues through the depreciation of the domestic currency in order to minimize the impact on the domestic economy but a hike in interest rates and a recession cannot be avoided. For the relevant parameterizations, optimal policy is fairly well approximated by a flexible targeting rule, in which a combination of domestic prices, exchange rate and output is stabilized. Strict exchange rate targeting achieves low welfare levels relative to other simple rules based on inflation and output in which the exchange rate is taken into account but not fully fixed.; The third essay, coauthored with Daria Finocchiaro, estimates a small open economy model for Sweden. We account for a regime change in monetary policy, from an exchange rate target zone to flexible exchange rates and inflation targeting. Results suggest that monetary policy reacted primarily to exchange rate deviations from central parity under the target zone, but inflation and output were not neglected. In the inflation targeting regime the interest rate reacted mainly to inflation. Expectations of realignment and risk premium volatility were the main sources of volatility in the target zone period. In the inflation targeting period, monetary shocks were important in the short run but in the long run labor supply and preference shocks are relatively more important. Shocks to foreign variables were more destabilizing in the target zone period than in the inflation targeting regime.