Essays on International Effects of Monetary Policy

Abstract

During recent decades the monetary policies of central banks have shown similar patterns - mostly led by the policy changes of large economies such as the US and the Eurozone. These large economies care little for other countries' monetary policies, while other economies have concerns about the fluctuations of international variables such as currency values and capital flows. This results in asymmetric relationships between the central bank policies across countries. The major central banks' quantitative policies also have significant effects on the other economies by way of changes to cross-border capital flows.

The first chapter presents (i) a theoretical framework that explains the asymmetric policy relationships and (ii) empirical evidence for those relationships. In the two-country model analysis, home welfare is approximated as a function of international variables. These variables also influence optimal home inflation and output. The optimal home policy rate is affected by the foreign policy rate, and the effect becomes stronger as home openness is greater. Therefore, when the degrees of openness are significantly different between countries, there can be an asymmetric policy rates relationship. The empirical analysis investigates the policy rate relationships between two large economies (the US and the Eurozone) and other economies. In the probit model analysis, 12 out of 14 countries have leader and follower relationships with at least one of the US and the Eurozone. The VAR analyses indicate that 11 countries have one-way relationships with the large economies.

In the second chapter, the leader-follower policy relationship between central banks is investigated based on a small open economy model. The asymmetric relationship is strengthened by economic globalization. When the foreign policy rate is lowered, the home currency appreciates. This leads to a decrease in net exports via the expenditure switching effect, thus reducing home output. The lower import price reduces home inflation. In response to the changes in home output, inflation and the real exchange rate, the home central bank lowers its policy rate. The policy relationship becomes stronger when (i) the international assets holding cost is lower, (ii) home openness is higher, (iii) the home central bank adopts more aggressive inflation targeting, and (iv) the home monetary policy responds to currency value changes. The banking friction also strengthens the policy relationship.

The third chapter models the international effects of quantitative easing (QE) in terms of cross-border capital flows. A two-country model is set up with financial frictions. The foreign central bank conducts QE. As the amount being loaned to home agents by foreign banks increases, capital stock, investment and the asset price of the home economy rise, accompanied by a currency appreciation. The fall in the foreign interest rate lowers the home interest rate through a decline in the home capital return. The financial accelerator strengthens the foreign QE effects. The rise in the asset price boosts home borrowers' net worth, and eventually investment and capital stock increase more. The international effects of QE are stronger with (i) a greater assets adjustment cost in the foreign economy, (ii) a lower home investment adjustment cost, and (iii) a higher degree of home financial openness.