Essays on exchange rate, inflation, and the role of monetary policy in small open economies

There has been a growing consensus that inflation reduction and price stability should be the primary long-term goal of monetary policy. One of the main controversies is related to the role of exchange rate in response to the over all objective of price stability in small open economies. The other is related to the effect of monetary policy on inflation.;Our investigation starts with the choice of monetary policies available to central bankers along with the consideration of the real historical events. More specifically, the work seeks to identify the variables, which play a crucial role in determining the likelihood of currency crises. It also focuses on measuring and ranking various indicators that send signals prior to the devaluation.;The multivariate panel probit model and nonparametric signal approach are used to complete the analysis. These methods can provide various useful information to monetary policy implications because they can predict the probability of devaluation for each indicator as well as for the over all country probability. The signal approach also provides average lead times of signals for each indicator and the ranking based on the predictive power of individual indicators. The results from our estimates from two methods are compared using many statistical criteria such as accuracy, calibration, and resolution. With the assumption of uncovered interest rate parity, the model can predict the average size of devaluation and the probability of devaluation for each country, which can be the guidance of the severity of the crisis. Our conclusion is that these methods are quite successful and appropriate to provide the early warning system for countries that conduct exchange rate based stabilization policy.;The third chapter examines the sources of fluctuations in real exchange rate, inflation, and output using a dynamic open economy aggregate demand---aggregate supply model under high capital mobility. Our empirical results, including core inflation estimated, indicate that inflation is mainly driven by monetary and real demand disturbances while the output is mainly driven by supply shocks. Cross country comparison shows that the persistence of inflation tends to be higher in countries that allow changing in exchange rate regime.