Essays on financial integration and monetary policy in small open economies

Date: 26 September 2014

Venue: University of Antwerp, Hof van Liere, Gresham and Elsschotroom - Prinsstraat 13B - 2000 Antwerp

PhD candidate: Mara Pirovano

Principal investigator: Prof. dr. Jacques Vanneste

Co-principal investigator: Prof. dr. André Van Poeck, prof. dr. Hans Dewachter

Short description: Phd defense Mara Pirovano - Faculty of Applied Economics

Abstract: This dissertation analyzes issues related to monetary policy and financial openness in small open economies presenting the characteristics of the new EU member states of Central and Eastern Europe. One empirical and two theoretical essays are presented, modeling a small open economy affected by domestic and foreign shocks. The first essay uses data on four new EU member states to study the interplay between stock prices and monetary policy (both domestic and Euro Area). The results reveal that, in these economies, stock markets are more sensitive to shocks related to external trade and finance than to domestic ones. The following, theoretical, essays embrace a DSGE framework, modeling the salient characteristics of the new EU member states and examining the conduct of monetary policy when the central bank is concerned with both macroeconomic and financial stability. The second essay studies the optimal monetary policy for a small open economy where foreign capital inflows finance investments in capital and housing, in an environment characterized by credit frictions and liability dollarization. Even when the central bank is not concerned with financial stability objectives, reacting to financial variables is not optimal in response to capital inflow shocks, while it is optimal to steer the interest rate in response to depreciating pressures on the currency. The final essay examines exchange rate policy in a small open economy engaging in cross-border borrowing and lending relationships characterized by credit frictions, concluding for the superiority of flexible exchange rate regimes in stabilizing the economy following adverse foreign shocks. While the cost for the monetary authority of pegging the currency increases the greater its concerns for financial stability, tighter cross-border lending relationships reduce the relative cost of pursuing a fixed exchange rate strategy.