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Essays on Monetary Policy in Emerging Market Economies


This dissertation addresses a number of important monetary policy issues in emerging markets, which are primarily related to capital flows and exchange rate movements and largely motivated by Thailand's experience. Thus, Chapter 1 reviews background information on Thailand's macroeconomic developments in the context of large and rapid exchange rate appreciation during 2006-2008.

Chapter 2 develops a micro-founded macroeconomic model in which sterilized foreign-exchange (FX) interventions are effective in influencing currency movements as well as real allocations. The effectiveness of FX interventions rests on the existence of liquidity benefits from holding financial assets. The analysis shows that such sterilized FX interventions can affect the domestic interest rate relevant for the consumption-saving decision through the change in the financial system's liquidity condition even when the policy interest rate is held constant. Simulation exercises based on the calibration aiming to capture the Thai economy suggest that the reliance on sterilized FX interventions to deal with capital flows can be welfare-improving, mainly due to liquidity benefits. However, the effect of liquidity-based sterilized FX interventions on the exchange rate dynamics is small. Furthermore, an accommodative interest rate policy appears essential for sterilized FX interventions to be fully effective.

Chapter 3 examines the viability of capital controls on inflows following Thailand's experience which experienced a stock market crash in consequence of the introduction of the unremunerated reserve requirement measure in December 2006. Both theoretical analysis and empirical evidence suggest that the predominant factor for the stock market crash was the punitive implicit tax rate that made any new foreign investment in the domestic stock market unprofitable. Occurring as a result of limited foreign participation, a revaluation of systematic risks relevant for idiosyncratic risk pricing as well as a reduction in stocks' liquidity led to a sharp increase in the equity premium. Consequently, share prices declined substantially. The importance of these two channels in triggering the stock market crash was largely supported by the findings that difference in covariances and trading frequency appear as the most important explanatory variables for changes in share prices across firms during the stock market collapse and rebound. In short, capital controls should remain a viable policy option provided that they are well-designed.

Chapter 4 illustrates how to apply the methodology developed by Obstfeld and Rogoff (2005) and (2007) to estimate the magnitude of exchange rate fluctuations required for absorbing changes in financial flows in addition to facilitating adjustments of the current account towards its medium-term position, with a particular focus on analyzing Thailand's exchange rate fluctuations in the past two decades. The simulation-based analysis points out that the Thai baht has been heavily influenced by the development of capital flows, and also suggests that some exchange rate misalignments were evident over certain time periods. Specifically, the Thai baht seemed relatively weak during 1999-2001, consistent with the export-led growth model propelled by a competitive exchange rate value, but it then appeared justifiably strong in 2006 when the Bank of Thailand seriously concerned about large and rapid currency appreciation. Nevertheless, the dynamics of the Thai baht over the past year has become more aligned with underlying factors that drive exchange rate movements.

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