Essays on economic interdependence

In an increasingly integrated world, economic events in one country can have relevant consequences for other countries. This dissertation focuses on the question of economic interdependence and the consequences of alternative exchange-rate regimes and policy rules. The chapters contain contributions to theory, as well as applications to transatlantic and North-American issues.;In Chapter 1, Barry Eichengreen and I develop a model of macroeconomic interdependence between the United States and Europe and use it to analyze the prospects for transatlantic policy cooperation. The model is in line with the traditional non-microfounded literature on interdependence. The novel feature consists of a careful analysis of the tradeoffs facing policymakers. In particular, we study how fiscal policymakers' incentives are affected by changes in exchange-rate regime and the degree to which taxation is distortionary. We argue that maintaining some distortion can be optimal. Policymakers' interest in cooperation is affected by the nature of fiscal policy.;In Chapter 2, I depart from the traditional literature and propose a microfounded model of the U.S. and European economies. The focus is on understanding the determinants of transatlantic interdependence. I perform a positive analysis of the consequences of policy shocks in the U.S. and Europe. Even if purchasing power parity does not hold across the Atlantic, transatlantic exchange rates do not overshoot their long-run levels following unexpected shocks. Monetary expansions can decrease domestic consumption relative to foreign if unfavorable wealth effects are sufficiently large.;Chapter 3 develops a model of interdependence that is more suitable for empirical investigation than those presented in the recent literature, including that of Chapter 2. One of the main problems in these models is the absence of a well-defined endogenously determined steady state. The steady state of the model presented in this chapter is entirely determined by the structural parameters. I also model nominal rigidity more explicitly than in previous contributions, and bring investment and capital accumulation into the scene. Markup dynamics play an important role in explaining business cycle fluctuations. In the second part of the chapter, I estimate the structural parameters of a small open economy, identifying the home economy in the model with Canada, and the foreign economy with the United States.;In Chapter 4, I use the model of Chapter 3 to evaluate the performance of alternative monetary rules for Canada. Different rules generate different dynamics by generating different behaviors of producer prices and the markup. Inflation targeting performs better than the Taylor rule. This rule---which dictates that the interest rate should react to inflation and output movements with coefficients 1.5 and .5, respectively---is destabilizing, because it does not adjust for exchange-rate depreciation. Its performance is improved if domestic CPI inflation is replaced by U.S. inflation in the rule and/or if a forward-looking rule is followed. Inflation targeting is preferable to fixed exchange rates on welfare grounds, but both are dominated by a constant interest rate path. All strict targeting rules are dominated by the depreciation-adjusted Taylor rule, which is consistent with "soft-hearted" inflation targeting. This notwithstanding, empirical evidence suggests that the recent behavior of the Bank of Canada is more consistent with strict inflation targeting than with the soft option.