Macroeconomics of small open economies

This thesis deals with topics in applied macroeconomics. Chapter 1 surveys the strand of literature in the field of open-economy macroeconomics which applies quantitative models to the issue of transmission properties of economic disturbances and international policy. I discuss the genesis of quantitative open-economy models, their ability to match the data, and their use as a laboratory for policy analysis. In doing so, I concentrate on studies dealing with the role of exchange rate stabilization in the conduct of monetary policy and the choice of exchange rate arrangement. In chapter 2, Taylor type interest rules which differ in the size of the reaction coefficient on the real exchange rate are compared with each other. I find that introducing a moderate form of real exchange rate targeting in the original Taylor rule induces higher welfare with respect to shocks to productivity and foreign demand and lower welfare with respect to shocks to government consumption and the terms of trade. However, the outcome under rules which, unlike the original Taylor rule, allow for a considerable degree of interest smoothing, is robust regarding the inclusion of real exchange rate targeting. In chapter 3, I repeat Jordi Gali’s (AER, 1999) VAR analysis of the effects of technology shocks on employment in the G7 countries, with two important modifications. First, I add an open-economy block to the vector of endogenous variables. Second, the use of structural vector error correction model methods allows me to investigate the effect of a productivity shock on employment based on less restrictive assumptions than Gali does. Gali’s findings, however, are largely confirmed: the response of employment to a positive technology shock is negative and persistent.