UC Santa Cruz

This dissertation has three chapters, with emphasis on the effects of external and internal shocks on international trade and finance from a different perspective. In the first chapter, the cash-in-advance model explores the precautionary savings against external shocks under different exchange rate regimes. The low-income countries mainly face external shocks from the current account, which includes productivity (internal), international aid, terms of trade, external demand, and foreign monetary policy. Agents hold assets to smooth the consumption under the floating exchange rate regime. However, the assets not only stabilize the exchange rate but also smooth consumption under the pegged exchange rate regime. Facing uncertainty, households put more weight on precautionary motive, instead of investment motive. The impulse response function reveals that the initial deviations are more significant with the pegged exchange rate regime because the nominal exchange rate can not absorb the macroeconomic shocks. The floating exchange rate regime could reduce the variance of domestic consumption, while the pegged exchange rate regime would be better to stabilize imported consumption. Furthermore, the foreign monetary policy shocks show significant differences between the two regimes.

The second chapter analyzes the impact of U.S. interest rate changes under cost-push shocks and natural rate shocks as well as these shocks' transmission to emerging market countries. The theoretical model of a small open economy finds that changed exchange rate (exchange rate channel) is negative - USD depreciation under cost-push shock, while positive - USD appreciation under natural rate shock. The differences under the two shocks are amplified through domestic bonds (financial market channel) and terms of trade (trade market channel). Then, the real output of the emerging economy with PPI-based Taylor rule is positive under both shocks and less volatile under cost-push shock, given the same magnitude of shocks. This chapter also uses Bayesian local projections to test empirical sample that consists of five emerging and five developed countries. As the model predicts, the exchange rate channel has significant and different effects under both shocks. The empirical results reveal that cost-push shocks cause more substantial volatility than natural rate shocks for each country due to their characteristics - significant deviation and less persistence through three channels. Overall, inflation targeting is one of the essential objectives for emerging economies and contributes towards more stable economic growth.

The third chapter implements a simple model to explain Chinese onshore and offshore financial markets and fill the gap of the term spread differential of money market and CIP violation of currency market spillover effects with internal shocks. China has not only both onshore and offshore money (capital) markets but also both onshore and offshore currency markets. The differences between onshore and offshore RMB markets would cause many questions that are worth probing into. The empirical test also uses a new flexible econometric method - Bayesian local projections that can sensibly reduce the impact of compounded biases over the horizons and effectively deal with model misspecifications. The results are three-fold: First, one market shock can transmit to the other market through capital flows. The shocks from the forward currency market have a significant impact on the spot money market through capital flows. The effects on both markets would die away in a week after initial shocks, but the effect on capital flows is less persistent. Second, cheaper net cost of issuance in offshore induces more issuance flow in offshore and less issuance in onshore. Third, a massive amount of debt issuance may decrease the absolute value of the net deviation.