Four essays on the theory of monetary policy

This dissertation focuses on the construction of macroeconomic models that can be used to evaluate monetary policy. The theoretical models developed for this purpose emphasize the importance of intertemporal optimizing behaviour, the role of expectations and nominal price rigidities.;The second essay (chapter 3) uses continuous-time modeling approach instead of the more conventional discrete-time approach and compares the performance of two rulebased targeting regimes—price-level targeting and nominal income targeting with and without the cost channel of monetary policy for a closed economy. Chapter 3 considers a series of macroeconomic models with different specifications for both the aggregate demand side and the aggregate supply side of the economy to check for robustness of results. It is assumed that the two targeting regimes generate the same outcome regarding long-term inflation. Thus, the criterion for evaluating the performance of a monetary regime is its ability to minimize the volatility in real output in response to aggregate demand shocks.;Using the type of models analyzed in chapter 3, chapter 4 introduces open economy considerations and looks at the performance of monetary policy (in terms of reducing volatility in real output) under three alternative targeting regimes: exchange rate targeting (fixed exchange rates), price-level targeting, and nominal income targeting (both flexible exchange rate options). Although the supply-side effects of the interest rate (the cost channel) are ignored, the supply-side effects of exchange rate changes (due to the existence of intermediate imported inputs) are highlighted.;Chapter 5 develops a discrete-time dynamic stochastic general equilibrium model with incomplete asset markets, nominal price rigidities and monopolistic competition to shed light on the role of the exchange rate and its relation with current account dynamics and domestic inflation in the formulation of monetary policy. Chapter 5 argues that the assumption of complete asset markets is not realistic in a model with imperfections and rigidities in goods market because, with nominal rigidities, monetary policy will affect real variables including the current account. With incomplete asset markets the dynamics of current account does matter for monetary policy because then, besides dealing with the distortions created by monopolistic competition, the central bank needs to address the inefficiencies caused by incomplete asset markets. (Abstract shortened by UMI.).;The first essay (chapter 2) compares the implications of the interest rate channel and the cost channel (when firms' marginal cost depends directly on the nominal interest rate) of the monetary policy transmission mechanism under inflation and price-level targeting regime for determining the optimal trade-off between stabilizing inflation and the output-gap in a forward-looking closed-economy model.