Date of Award
Doctor of Philosophy (PhD)
Ufuk Devrim Demirel
This dissertation studies issues on the macroeconomic stabilization policies in emerging market or developing countries. Specifically, I investigate an impact of the macroeconomic policy regimes and other factors on the fluctuations of business cycles. I investigate issues concerning the procyclical trend of fiscal and monetary policies in a closed economy under imperfectly developed infrastructure, a small open economy case of central banking problem with a restricted financial market accessibility and labor market distortions, and an impact of governmental wage support on consequences of negative external shock. One of the main goal of this dissertation is to investigate how a macroeconomic policy can optimally stabilize the economic volatility and how it can improve a social welfare gain.
In the first chapter, I build a small open economy dynamic stochastic general equilibrium (DSGE) model, and solve a Ramsey policy problem by using a linear-quadratic (LQ) welfare loss function to investigate the optimal monetary policy in developing economies. To capture realistic sides of the region, I add two frictions in the model: An imperfect financial market integration captured by a quadratic financial adjustment cost in a budget constraint of a representative domestic household, and a labor market friction captured by a quadratic labor adjustment cost in a production process of a monopolistic competitive domestic firm. While the financial market friction exacerbates the trade-off between output gap and domestic inflation stabilization faced by policy makers and creates higher level of economic volatility, the labor market friction softens the negative effect of the imperfectly integrated financial market by mitigating the trade-off. I also evaluate alternative monetary policy candidates, and find that a policy emphasizing the domestic inflation stabilization yields higher welfare cost than a policy weighing on the output gap stabilization.
A Rich volume of literature points out that many developing countries have experienced procyclical macroeconomic policies in recent period while most developed countries have not, but the reason of the phenomenon is still in debate. In the second chapter, I theoretically investigate an optimal fiscal and monetary policy in an economy where an institutional cost associated with public goods influences on economic dynamics and cyclicality of macroeconomic stabilization policies. Based on a simple New Keynesian DSGE model, a real quadratic adjustment cost that is created by a government spending spread between current and efficient level of the public expenditures is invited. This cost captures a negative effect of the newly created institutional cost on trade-off between inflation gap and output gap stabilization encountered by policy authority. As a result, solving Ramsey policy problem with a linear-quadratic welfare loss function, I find that the optimal fiscal and monetary policy tend to be more procyclical and the economy experiences higher level of volatility in the presence of the institutional cost. Comparing alternative monetary policy regimes based on Taylor rule, I find that a forward looking inflation rate targeting rule reduces procyclicality of fiscal and monetary policy and yields a significant improvement in welfare gain, while aggressive stabilization strategy on inflation gap or output gap has no economic merit.
In the last chapter, I investigate the role of real wage changes in the dynamic responses of the optimal macroeconomic policy to the negative foreign demand shocks, where the wage structure is partly affected by a manually operated by a government. To do this, I build a small open economy DSGE model with a sticky price and a monopolistically competitive nontradable sector assumptions. If a government manually supports the domestic consumers by a binding minimum wage which is financed by a lump sum taxation, the optimally determined the real marginal cost in the New Keynesian Phillips Curve (NKPC) is decreased, and thus the economy experiences less exacerbated trade-off between output gap and inflation stabilization faced by a policy maker. Therefore, with the higher level of the real wage support, an economic volatility in key macroeconomic variables from the optimal Ramsey policy problem is more mitigated, and the economy accomplishes more efficient stabilization goal.
Kim, Jongheuk, "Essays on Optimal Macroeconomic Stabilization Policy for Developing Economies" (2014). Economics Graduate Theses & Dissertations. 3.