UC Santa Cruz

This dissertation studies topics of international finance, such as the use of international reserves as a tool of monetary policies by Emerging Markets (EM), the impact of trade costs in cross-country risk sharing, and the new observed deviations from covered interest rate parity. Each chapter of the dissertation approach one of these three topics.

The first chapter investigates extended Taylor rules and foreign exchange intervention functions in large Emerging Markets (EM), measuring the extent to which policies are designed to stabilize output, inflation, exchange rates and accumulate international reserves. We focus on two large emerging markets - India and Brazil. We also consider the impact of greater capital account openness and which rules dominate when policy conflicts arise. We find that output stabilization is a dominant characteristic of interest rate policy in India, as is inflation targeting in Brazil. Both countries actively use intervention policy to achieve exchange rate stabilization and, at times, stabilizing reserves around a target level tied to observable economic fundamentals. Large unpredicted intervention purchases (sales) accommodate low (high) interest rates, suggesting that external operations are subordinate to domestic policy objectives. We extend the work to Chile and China for purposes of comparison. Chile’s policy functions are similar to Brazil, while China pursues policies that substantially diverge from other EMs.

The second chapter empirically examines whether trade costs impede cross-country consumption risk sharing. Using the data for a large panel of countries over the period 1970-2014, we document that bilateral risk sharing improves once a pair of countries become partners under a regional trade agreement. Moreover, we establish a gravity model of consumption risk sharing by finding that bilateral risk sharing decreases in geographical distance between countries. The effect is more pronounced in the absence of regional trade agreements. These empirical findings support the argument that lifting trade barriers promotes risk sharing across countries. \par

The third and last chapter examines the deviation from covered interest rate parity. Being a new phenomena observed especially after the 2008 Great Financial Crisis (GFC), we measured the deviations in a cross-country setup, and explored possible causality channels for this behavior. The empirical findings in this chapter show a big heterogeneity of causalities per country, limiting the possibilities of a unified theoretical model to explain it.