Three essays on monetary economics

This dissertation consists of three essays on monetary economics. The first chapter investigates the relation between interest rate policy and nominal exchange rate volatility. Using data of countries in currency crisis, I employ a time-varying-transition-probability (TVTP) Markov-switching model to study the interest rate-exchange rate nexus. The empirical results support the view that a high interest rate policy is unable to defend the exchange rate. The second chapter studies the impact of macroeconomic policy by introducing different policy shocks into an equilibrium business cycle model. In particular; monetary policy is modelled as an interest rate rule (Taylor Rule) to investigate liquidity effects and persistence in output and inflation. Without assuming price stickiness or frictions in financial markets, the model can account for liquidity effects, generate high persistence in output and inflation, and capture positive cross-correlations between inflation and output. The third chapter (with Charles M. Engel) revisits the role of heterogeneity and aggregation bias in explaining the purchasing power parity (PPP) puzzle. First, it clarifies the meaning of aggregation bias and its applicability to the PPP puzzle. Second, the size of the "bias" is shown to be small. Third, we show that the presence of non-persistent measurement error can make price series appear less persistent than they really are. Finally, after correcting small sample bias, the half-life estimates indicate that heterogeneity and aggregation bias do not help to solve the PPP puzzle.