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Foreign Exchange And Monetary Policy: Essays From A Developing Country Perspective


The first essay investigates the participation of an IT-central bank in the exchange rate market, as a supplemental tool for monetary policy. It presents a way of modeling a hybrid IT-regime with a managed float for a small open economy. The strategy followed, differs from most approaches that combine IT with partial control over the exchange rate, in that it uses the exchange rate as an operational target and interventions as instrument. The analysis is done in a general equilibrium setting, considering a financial system dominated by commercial banks, who solve an optimization problem giving rise to a premium in the UIP condition; Central bank's behavior is described by two rules: a policy rate in a Taylor-type rule and another one describing the accumulation of international reserves. The model suggests that, when shocks affecting the economy are supply shocks, intervention in forex market can render better results than just re-setting the policy rate, in the sense that it reduces volatility of inflation, keeping it closer to its long run-level. For other type of shocks, intervention exacerbates inflation volatility.

The second essay explores the effectiveness of forex interventions within an IT- contex using Guatemalan daily data from 2008 to 2012, as a case study. In a first stage, I estimate the central bank reaction function, using a friction model à la Rosett. In a second stage, I use the conditional expectation of intervention, generated with estimates of the reaction function, as an instrument for actual interventions in a reduced form model of the exchange rate daily-returns, allowing for GARCH effects in the conditional variance. Results show statistical evidence of the existence of threshold effects in the reaction function, and indicate that intervention operations during the sample period, influenced the variance, but not the level of exchange rate. The central bank reacted systematically to previous-day exchange rate changes, when deciding the amount of intervention, and also to deviations from a short-term trend. Despite intervention had a dampening effect over the daily exchange rate return's volatility, they do not appear to be the main cause of the remarkable stability of the nominal exchange rate in Guatemala.

The final essay deals with the fact that emigrant remittances have been growing around the world since 1970, but in the past few years, their growth rate has enlarged significantly. In Guatemala, remittances have increased their nominal value in about 142 percent over the last decade and there is concern with the idea that large and sustained remittance inflows can provoke an appreciation of the real exchange rate, making the production of tradable goods less profitable; a Dutch-Disease-like phenomenon. This essay explores how remittance flows affect the real exchange rate in the Guatemalan economy using a stochastic, dynamic general equilibrium model. The model generates a real exchange rate appreciation, a tradable sector contraction, and a non tradable expansion, similar to those that are observed in national accounts data; within the model, capital adjustment costs and heterogeneous labor play a predominant role in mimicking the dynamics of the observed real exchange rate appreciation. In addition, the results suggest that, in Guatemala, economic agents perceive the observed shift in the remittances flow as permanent.

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