"Essays on Monetary Policy of Small Open Economies"

In this dissertation, I address two questions about the monetary policy of small open economies. The first chapter of my dissertation, entitled "US Monetary Policy and Macroeconomic Fluctuations in Small Open Economies: A VAR analysis," documents empirical evidence about the effects of US monetary policy on small open economies using a VAR model and Korean data. For identification, I adopt `block exogeneity' to Korean economy block and `recursive restriction' to the rest of the world block. I find that US monetary policy and other external shocks are important factors that affect the fluctuation of variables in Korea. The way the external factors affect the countries has changed over time. Before the financial crisis in 2008, the effects are concentrated in a short period of time and disappear fast. After the crisis, the external shocks tend to have a longer-run effects than before.

The second chapter, entitled "Interest Rate Differential and the Response of Small Open Economies: Empirical and Welfare Evaluation," explores the reason why central banks in small open economies respond to the interest rate differential relative to the US. First, I conduct a regression analysis to show that the interest rate differential is significantly associated with the monetary policy of small open economies and this is true even after controlling for the domestic factors and exchange rate variation.
Next, to investigate the empirical findings, I develop a structural model in which a foreign borrowing and domestic investment are constrained by the decision of the foreign lenders. The optimal decision of the foreign lenders are affected by the interest rate differential. Bayesian estimation shows that the model in which the central bank uses the interest rate differential as an important information is strongly preferred by data to other widely used policy rules in which the central bank focuses on stabilizing domestic variables or the exchange rate. Moreover, the model is in line with the VAR evidence of the first chapter. Finally, welfare analysis shows that responding to the interest rate differential is welfare enhancing since it prevents the drastic fluctuation of capital flows to the changes in US monetary policy by affecting the decision of foreign lenders.