Inflation in an open economy: Inflation bias, adaptive learning, and escape dynamics

The theoretical dissertation is a series of studies on inflation bias, adaptive learning, expectational stability, self-confirming equilibrium and escape dynamics in open-economy monetary economics. This dissertation is composed of three independent papers. It is well-known that when policymakers have an inherent inflation bias, this bias can impact macroeconomic coordination between countries. The extent to which it alters learning dynamics and optimal policy design in open economies are important unanswered questions. This dissertation aims to partly fill this gap.;The paper "Inflation Bias and Optimal Monetary Policy in An Open Economy" is presented in chapter 1. It is well-known that there are unique challenges to design optimal monetary policy in an open economy because of the tempering effect of the real exchange rate channel: a high inflation in one country would depreciate its currency to make domestic inflation greater. Under non-coordination, governments realize that lowering unemployment is more costly due to the existence of a tempering influence. With coordinated policy, however, policymakers are more likely to inflate since the effect of tempering is removed. To investigate the impact of a change in the degree of inflation bias on the optimal time consistent monetary policy, this paper establishes a two-country framework and compares outcomes under three different scenarios. The theory demonstrates that, under either coordination or non-coordination, a greater degree of inflationary bias in one country will lead its own inflation policy to increase if the effect of unanticipated domestic inflation surprises is stronger than the effect of the real exchange rate channel. Moreover, the potential gains to countries coordinating exchange rate policy depends on the relative degrees of inflation bias between the two economies.;The purpose of the chapter 2 paper "Adaptive Learning in A Small Open Economy" is to explore whether rational expectations equilibria are stable when rational expectations are replaced with a reasonable learning rule. We examine the expectational stability conditions of rational expectations equilibria in a small open economy environment. Our theoretical results suggest that, the MSV REE price level under a system of fixed exchange rates is expectationally stable. However, more generally, the full set solutions of REE price level under fixed exchange rates regime are neither stationary nor expectationally stable.;The paper "Escaping Inflation and Regime Switches in An Open Economy" is presented in chapter 3. We seek to understand how an expansive monetary policy in one country, say the United States, spread high inflation to other countries during 1970s-80s? Two intuitions have been used to answer this question. One is from Sargent (1999), who asserts that the government's attempts to exploit a trade-off empirical Phillips curve would yield an inefficiently high inflation. The other is from Rogoff (1985a), who claims that international coordinated policy between central banks can produce an excessively high inflation. The purpose of this paper is to combine these two intuitions to investigate how the international monetary policy interaction affected the transmission of inflation across countries during and after the Bretton Woods era. Our finding reveals that sudden policy regime switching from leader-follower system to non-coordination scenario makes policymakers come to realize that there exists an expectations-augmented Phillips curve embodying a version of the natural rate hypothesis. Moreover, our simulation results can explain why inflation arose again after the collapse of Bretton Woods system then decreased to a lower level in the early 1980s.