This dissertation offers three essays addressing critical topics in financial market dependence and monetary policy transmission in an era of financial integration: 1) the domestic effects of monetary policy (MP) shocks on market interest rates in small open economies, 2) international transmission of U.S. MP shocks to other open financial markets, and 3) volatility spillovers among financial markets in emerging market (EM) economies. The first chapter investigates the nature of monetary policy transmission in selected small open economies and the U.S. by estimating structural vector autoregressive (SVAR) models using the external instrument identification method. Differing from related studies on U.S. monetary policy, which mostly employ high-frequency futures rates to identify monetary policy shocks, the study proposes and tests alternative sets of external instruments for the focal open economies that do not yet have well-established futures markets in MP instruments. The second chapter focuses on the international transmission of U.S. monetary shocks into a variety of financial markets in open economies. I again exploit the external instrument approach to identify the impact of U.S. and domestic MP shocks in a SVAR system. Utilizing the identified shocks for the event study analysis and the local projection estimation, I further test non-linear features of such transmission. Empirical results from the first and second chapters provide a variety of meaningful insights. The results show that foreign exchange rates respond to monetary shocks flexibly, i.e., without generating puzzles raised by earlier studies and that the shocks strongly propagate into other types of open financial markets as well. The studies also confirm the significant transmission of domestic monetary shocks in open economies, but U.S. shocks appear to exhibit greater and more persistent influences over domestic asset prices than domestic shocks. Besides, the international propagation of U.S. shocks also demonstrate non-linear features. The third chapter investigates the occurrence of dependency between foreign exchange markets and stock markets in EM countries by testing volatility spillovers of asset returns. I modify the classical BEKK GARCH (1,1) model to study the dynamics and origins of volatility spillovers. The empirical results are threefold. First, volatility spillovers between financial markets are significant in most EM countries. Second, such spillovers are found to be contingent on the sample period and market conditions, a result that is generally consistent with findings in the literature on time-varying, asymmetric, and contagion-shift spillovers. Finally, the results suggest that, under normal conditions, the relevant spillovers are explained mostly by comovement from common information about fundamentals; during crises, however, while common information plays a role, market contagion also becomes an important source of spillovers.

In the first chapter, I quantify the welfare effect of eliminating the U.S. capital income tax under international financial integration. I employ a two-country, heterogeneous-agent incomplete markets model calibrated to represent the U.S. and the rest of the world. Short-run and long-run factor price dynamics are key: after the tax reform, post-tax interest rate increases less under financial openness relative to autarky. Therefore the wealth-rich households gain less. Post-tax wages also fall less, so the wealth-poor are hurt less. Hence, the fraction in favor of the reform increases, although the majority still prefers the status quo. Aggregate welfare effect to the U.S. is a permanent 0.2 % consumption equivalent loss under financial openness which is 85.5 % smaller than the welfare loss under autarky. The second chapter aims to answer two questions: What helps forecast U.S. inflation? What causes the observed changes in the predictive ability of variables commonly used in forecasting US inflation? In macroeconomic analysis and inflation forecasting, the traditional Phillips curve has been widely used to exploit the empirical relationship between inflation and domestic economic activity. Atkeson and Ohanian (2001), among others, cast doubt on the performance of Phillips curve-based forecasts of U.S. inflation relative to naive forecasts. This indicates a difficulty for policy-making and private sectorâs long term nominal commitments which depend on inflation expectations. The literature suggests globalization may be one reason for this phenomenon. To test this, we evaluate the forecasting ability of global slack measures under an open economy Phillips curve. The results are very sensitive to measures of inflation, forecast horizons and estimation samples. We find however, terms of trade gap, measured as HP-filtered terms of trade, is a good and robust variable to forecast U.S. inflation. Moreover, our forecasts based on the simulated data from a workhorse new open economy macro (NOEM) model indicate that better monetary policy and good luck (i.e. a remarkably benign sample of economic shocks) can account for the empirical observations on forecasting accuracy, while globalization plays a secondary role.

International economic integration has risen during the last decades and the interdependence between each economy and the rest of the world has become central for policy decisions. My dissertation contributes to the debate about the conduct of monetary policy in a financially integrated world. In the first chapter of the dissertation I discuss the relationship between domestic policies and the currency denomination of foreign debt. Foreign debt is a double-edged sword. It allows countries to invest more than what would be possible given their own savings, thereby achieving preferable allocations that would not otherwise be feasible. However, it is the root of several crises. Foreign debt is especially hazardous when denominated in foreign currency; in such cases exchange rate depreciations increase the real value of the debt. An important question then is what determines the currency denomination of foreign debt. I use the adoption of Inflation Targeting (IT) in several economies during the last two decades to evaluate the importance of domestic policies in the determination of the currency denomination of debt. In order to control for possible endogeneity in IT adoption, I use matching and instrumental variables estimators; both generate similar estimates. The results show that monetary policy can have substantial effects on the amount of debt in foreign currency and that a more flexible exchange rate regime increases the use of domestic currency in foreign borrowing. In the second chapter of the dissertation I investigate the relationship between central banks balance sheets and monetary policy. Heavy foreign exchange intervention by central banks of emerging markets have led to sizeable expansions of their balance sheets in recent years - accumulating foreign assets and non-money domestic liabilities (the latter due to sterilization operations). With domestic liabilities being mostly of short-term maturity and denominated in local currency, movements in domestic monetary policy interest rates can have sizable effects on central bank's net worth. In this chapter I examine empirically whether balance sheets considerations influence the conduct of monetary policy. The methodology involves the estimation of interest rate rules for a sample of 41 countries and testing whether deviations from the rule can be explained by a measure of central bank financial strength. My findings, using linear and nonlinear techniques, suggest that central bank financial strength can be a statistically significant factor explaining large negative interest rate deviations from "optimal" levels. In the third chapter I investigate whether countries that adopted the IT framework for monetary policy have been constrained by exchange rate consideration when taking policy decisions. I present stylized facts which suggest that exchange rates have been allowed to float relatively free in IT countries. I employ Bayesian Analysis techniques to estimate a Dynamic Stochastic General Equilibrium (DSGE) structural model for twenty two IT economies and compute posterior odds tests to check whether the central banks systematically respond to exchange rate movements. The main result is that only five central banks directly respond to exchange rate movements; all the other IT central banks do not respond to the exchange rate. I also confirm that IT central banks have been conducting strictly inflationary policies, raising real interest rates in response to increases in inflation.

The essays brought together in this volume share a common objective: To bring a unifying methodological approach to the analysis of financial problems in developing, open economies. While the primary focus is on contemporary Latin America, the methods employed and the lessons learned are of wider applicability. The papers address the financial integration issue from three different perspectives. In some cases, a country study is the vehicle for an econometric investigation of a particular external linkage. In other cases, an individual country's experience suggests an economic model in which the stylized facts may be analyzed and developed. A third direction is unabashedly theoretical and formulates more general principles which are broadly applicable rather than country-specific.

Recoge: 1.International co-ordination of economic policies: difficulties and perspectives - 2.Approaches to external disequilibria - 3.International and regional monetary problems - 4.European monetary integration.