Inflation and banking, foreign reserves, and exchange rates: Essays in the macroeconomics of developing countries

Chapter I studies the role of banks as magnifiers of the inflation-tax distortion. A general equilibrium model for a small open economy is developed to show how banks, even in a deterministic setup and assuming a zero-cost banking technology, exacerbate the effect of inflation on the level of employment. The model assumes that firms have to cover their financial needs by borrowing from banks. This issue is of crucial importance in most developing countries where banking credit is by far the most important source of funds for firms. The model shows that, in an inflationary environment, if banks are require to hold reserve deposits, then the steady-state equilibrium level of employment is lower. Moreover, the model finds a wide range of parameters for which the reserve requirement affects the sensitivity of employment to inflation.;Chapters II and III extend the previous chapter in different directions. Chapter II includes a cost function for the banking sector, which displays economies of scale. The paper shows that, in the presence of economies of scale, the inflation distortion is amplified even further. Chapter III explores the welfare implications of increases in the central bank's net foreign assets. This issue arises from the existence of a spread between the lending and borrowing interest rates, which captures a feature of international-credit markets that is particularly important for developing economies. The model provides a concrete measure of the opportunity cost of holding reserves and allows the study of its general equilibrium interactions.;Finally, Chapter IV develops and applies a model of the credibility of the Uruguay's target zone from 1993 trough 1999. The model constructs measures of the perceived likelihood and size of a jump in the value of the peso. These measures are based on a threshold model of the perceived timing of exchange rate jumps. The analysis finds that the few periods where credibility was eroded significantly are associated with domestic economic and political developments, and to some degree, with external events.