| While the empirical and theoretical aspects of closed economy monetary policy have been extensively studied, it is only recently open economy analysis has begun to receive attention. This dissertation attempts to contribute to this literature.; In chapter one, a model of a small open economy with nominal rigidities is presented. This chapter attempts to calculate the cost associated with the monetary policy rules followed in eight European counties for the last fifteen years. To do this, a welfare loss function is taken and on its basis, two welfare loss minimizing policy rules are obtained. These constitute benchmarks for the analysis. Interestingly, we find that the internationally oriented rule minimizes welfare loss. Comparing these rules to the eight estimated policy rules, we find that actual behavior approximated welfare loss minimizing behavior.; In chapter two, the inflation targeting choice faced by a small open economy is analyzed. The economy is small in the sense that it is unable to affect the bilateral exchange rate of its currency against that of a much larger trading partner. A model of such an economy is presented, and the choice between CPI-inflation treating and domestic inflation targeting studies by comparing the associated stabilization properties. Since the economy imports consumption and production goods, the choice is non-trivial for the central bank. We find that the flexible CPI-inflation rule provides the greatest amount of stabilization in the face of inflation shock.; The final chapter determines the extent to which nine EU central banks reacted to domestic economic conditions despite the constraints of EU membership. Monetary policy rules were estimated for these economies, and surprisingly, even countries that pegged their currencies to the German mark appeared to react to domestic conditions. To eliminate the possibility that the domestic inflation rate enters merely because it predicts the future course of the macroeconomy, we estimate an equation in which central banks use the spread between the domestic and the German are able to say find that currencies that followed the German mark closely did not have independent monetary policies. |
