Inflation stabilization, monetary policy instruments and borrowing constraints

The two most popular monetary policy instruments that have been used as nominal anchors to tackle the scourge of inflation are the money supply and the exchange rate. The programs that have used the money supply as the nominal anchor have had a different set of outcomes than those that have used the exchange rate as the nominal anchor. This thesis will study both these stabilization programs and analyze some of the characteristics associated with these programs.;My first essay analyzes Exchange Rate Based Stabilization Programs. Specifically, I examine the constraints placed on a government's exchange rate and balance of payments policies in an economy in which international capital flows are limited. In the context of a simple theoretical example, I describe the pressures on a country's central bank, implementing an exchange rate based stabilization, to sell its foreign exchange reserves when the country is subject to an unanticipated shock in the form of an external borrowing constraint. This simple theoretical model is then used to study the stylized facts associated with an Exchange Rate Based Stabilization Plan. It thus tries to establish the mechanism through which an exchange rate based stabilization could end up in a sustained loss of reserves and hence culminate in balance of payments crisis.;In my second essay I proceed to establish numerically the appropriate choice of monetary policy instrument when an economy is subject to money demand shocks arising due to financial innovation. I then proceed to establish the appropriate choice of monetary policy instruments (again numerically) in a scenario in which the economy faces shocks to the real sector arising due to shocks to government expenditure. Numerical computations involve measuring welfare gains associated with choosing one instrument over the other. I compare and contrast the policy measures in the two cases.