Essays on External Debt Structure and vulnerabilities in Sudden Stop Prone Economies

Toprak, Hasan, Economics - Graduate School of Arts and Sciences, University of Virginia
Korinek, Anton, AS-Economics (ECON), University of Virginia

This dissertation examines the role of external liability structure on the vulnerabilities and the necessary policy design in economies prone to sudden stops. Accounting for different types of capital flows, the first and second chapters study whether monetary policy in emerging market economies should be prudential, i.e., deviate from price stability to induce agents to borrow less and hold more insurance during tranquil times. In the first chapter, I develop a New Keynesian open economy model in which agents can trade a variety of international assets subject to a collateral constraint, then I derive a set of theoretical results. In the second chapter, I calibrate the model and conduct a quantitative analysis. From these analyses, I find that there is no scope for prudential monetary policy if either (1) the government can regulate both the level and composition of capital inflows or (2) commitment is not possible and the government can only regulate the volume but not the composition of flows. Otherwise, monetary policy should be prudential, though it is less effective than capital controls, especially without commitment. Compared with single bond setups, having multiple securities further reduces monetary policy’s capability to act in a prudential manner. These results suggest that macroprudential instruments that target both the level and composition of capital inflows are an essential part of an optimal policy mix. When capital controls are not available, committing to a simple inflation targeting rule delivers higher welfare than discretionary prudential monetary policy.

The third chapter explores the transmission of U.S. monetary policy to small open economies, specifically focusing on the role of real debt revaluation channel. The paper presents a tradable-nontradable sectors small open economy model and introduces two channels of monetary transmission - capital flows and debt revaluation. The strength of the debt revaluation channel depends on the dollar's share in both external debt and trade. Using high-frequency data, the paper empirically shows that countries with a larger "exposed debt", a measure of real debt value sensitivity to dollar fluctuations, are more affected by U.S. monetary policy shocks. The findings emphasize that both the level and currency composition of external debt, relative to that of trade, are critical in international monetary policy transmission.

PHD (Doctor of Philosophy)
sudden stops, capital flows, financial crisis, optimal monetary policy, capital controls, US monetary policy spillovers
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