Three essays on open economy macroeconomics

Abstract

This thesis consists of three papers on open economy macroeconomics. The first paper investigates the welfare implications of a fiscal transfer rule between members of a monetary union. I build a two-country model where banks are exposed to sovereign risk. I show that the costs of expansionary fiscal policy can outweigh the benefits due to the added pressure on sovereign spreads. This is magnified when the fiscal stance is weak. On the contrary, inter-governmental transfers mitigate the fiscal strain and provide stimulus to the economy. Yet, I find that sound fiscal stances are crucial both for governments to countervail shocks on their own, and also to grant support for the implementation of the transfer scheme. The second paper lays out an empirical model to compare the propagation of exogenous shocks in a small open economy subject to structural change. As the identification of shocks is time invariant, I am able to investigate the difierences that pertain only to structural change. I estimate the model to Australia and find a regime transition occurring in 1990. The responses of domestic variables to the shocks are less exacerbated and adjust quicker after the transition. I find that increases in commodity prices are only infiationary after 1990 and as a reaction to world demand shocks, whereas commodity-market shocks are recessionary. In the last paper, I study the implications of relative wage rigidities for monetary policy in a small commodity-exporting economy. I present a model where wages in the non-commodity sector are indexed to wages in the commodity sector, generating relative wage rigidities. For a high degree of indexation, I find some inflation is desirable. As wages are set in nominal terms, inflation partially offsets the effects of indexation on real wages. Nevertheless, as indexation is itself inflationary, the response of monetary policy to inflation still needs to be stronger. I show that policy misspecification is more problematic for higher degrees of indexation.