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In Korea, an inflation targeting (IT) regime was adopted in the aftermath of the Korean currency crisis of 1997–1998. At that time, the Bank of Korea (BOK) shifted the instrument of monetary policy from monetary aggregates to interest rates. Recently, central bank policymakers have confronted more uncertainties than ever before when deciding their policy interest rates. In this monetary policy environment, it is worth exploring whether the BOK has kept a conservative posture in moving the Korean call rate target, the equivalent of the US Federal Funds rate target since the implementation of an interest rate-oriented monetary policy. Together with this, the global financial crisis (GFC) of 2007–2009 provoked by the US sub-prime mortgage market recalls the following question: should central banks pre-emptively react to a sharp increase in asset prices? Historical episodes indicate that boom-bust cycles in asset prices, in particular, house prices, can be damaging to the economy. In Korea, house prices have been evolving under uncertainties, and in the process house-price bubbles have been formed. Therefore, in recent years, central bankers and academia in Korea have paid great attention to fluctuations in asset prices. In this context, the aims of this thesis are: (i) to set up theoretical and empirical models of monetary policy under uncertainty; (ii) to examine the effect of uncertainty on the operation of monetary policy since the adoption of interest rate-oriented policy; and (iii) to investigate whether gradual adjustment in policy rates can be explained by uncertainty in Korea. Another important aim is (iv) to examine whether house-price fluctuations be taken into account in formulating monetary policy. The main findings of this thesis are summarised as follows. Firstly, as in advanced countries, the four stylised facts regarding the policy interest rate path are found in Korea: infrequent changes in policy rates; successive changes in the same direction; asymmetric adjustments in terms of the size of interest-rate changes for continuation and reversal periods; and a long pause before reversals in policy rates. These patterns of policy rates (i.e., interest-rate smoothing) characterised the central bank‘s reaction to inflation and the output gap as being less aggressive than the optimising central bank behavior would predict (Chapter 3). Secondly, uncertainty may provide a rationale for a smoother path of the policy interest rate in Korea. In particular, since the introduction of the interest rate-oriented monetary policy, the actual call money rates have shown to be similar to the optimal rate path under parameter uncertainty. Gradual movements in the policy rates do not necessarily indicate that the central bank has an interest-rate smoothing incentive. Uncertainty about the dynamic structure of the economy, which is dubbed ‗parameter uncertainty‘, could account for a considerable portion of the observed gradual movements in policy interest rates (Chapter 4). Thirdly, it is found that the greater the output-gap uncertainty, the smaller the output-gap response coefficients in the optimal policy rules, and in a similar vein, the greater inflation uncertainty, the smaller the inflation response coefficients. The optimal policy rules derived by using data without errors showed the large size of the output-gap and inflation response coefficients. This finding confirms that data uncertainty can be one of sources explaining the reasons why monetary policymakers react less aggressively in setting their interest rate instrument (Chapter 5). Finally, we found that house prices conveyed some useful information on conditions such as possible financial instability and future inflation in Korea, and the house-price shock differed from other shocks to the macroeconomy in that it had persistent impacts on the economy, consequently provoking much larger economic volatility. Empirical simulations showed that the central bank could reduce its loss values in terms of economic volatility, resulting in promoting overall economic stability when it responds more directly to fluctuations in house prices. This finding provides the reason why the central bank should give more attention to house-price fluctuations when conducting monetary policy (Chapter 6).

This thesis examines the measurement, applications and properties of consumer inflation expectations in the context of eight European Union countries: France, Germany, the UK, Spain, Italy, Belgium, the Netherlands and Sweden. The data proceed mainly from the European Commission's Consumer Survey and are qualitative in nature, therefore requiring quantification prior to use. This study first seeks to determine the optimal quantification methodology among a set of approaches spanning three traditions, associated with Carlson-Parkin (1975), Pesaran (1984) and Seitz (1988). The success of a quantification methodology is assessed on the basis of its ability to match quantitative expectations data and on its behaviour in an important economic application, namely the modelling of wages for our sample countries. The wage equation developed here draws on the theoretical background of the staggered contracts and the wage bargaining literature, and controls carefully for inflation expectations and institutional variables. The Carlson-Parkin variation proposed in Curto Millet (2004) was found to be the most satisfactory. This being established, the wage equations are used to test the hypothesis that the advent of EMU generated an increase in labour market flexibility, which would be reflected in structural breaks. The hypothesis is essentially rejected. Finally, the properties of inflation expectations and perceptions themselves are examined, especially in the context of EMU. Both the rational expectations and rational perceptions hypotheses are rejected. Popular expectations mechanisms, such as the "rule-of-thumb" model or Akerlof et al.'s (2000) "near-rationality hypothesis" are similarly unsupported. On the other hand, evidence is found for the transmission of expert forecasts to consumer expectations in the case of the UK, as in Carroll's (2003) model. The distribution of consumer expectations and perceptions is also considered, showing a tendency for gradual (as in Mankiw and Reis, 2002) but non-rational adjustment. Expectations formation is further shown to have important qualitative features.

In recent decades, an increasing number of countries have adopted inflation targeting (IT) as a framework for monetary policy, wherein the country's central bank attempts to steer actual inflation toward a projected target rate. However, the question still remains whether or not IT can work in low-income countries experiencing hyperinflation, such as Venezuela. One of the main challenges facing such countries is the lack of credibility of their monetary institutions. Inflation targeting may help restore this credibility by committing the central bank to a transparent and accountable monetary policy. This paper delves into the theory of inflation targeting, examines the benefits and challenges associated with IT, and discusses the specific challenges that Venezuela may face when adopting IT. The paper also emphasizes the importance of accurate economic data in developing effective monetary policies and argues that forecasting can play a critical role in predicting the effectiveness of IT in Venezuela. Empirical evidence from other countries that have implemented inflation targeting will also be used to provide insights into the potential benefits and challenges of this policy for Venezuela.

Chapter 1, co-authored with Scott Schuh, examines whether the Taylor Rule still adequately captures monetary policy despite unconventional monetary policies (UMP) and the policy rate near zero in 2009-2015. We find structural breaks at 2007:Q3 in macro models with a shadow funds rate. Taylor Rule coefficients shift back toward pre-1984 estimates and breaks occurred in non-policy parameters. Results are similar with the effective funds rate, so either breaks are not due to UMP or the shadow rate is an insufficient specification of UMP. Chapter 2 incorporates the term structure and the Fed’s average inflation targeting (AIT) framework into the model of Sims and Wu (2020) with an occasionally binding zero-lower bound. When agents know the Fed's policy rule, AIT stabilizes inflation and utility compared to standard inflation targeting. Inflation is most stable, and utility is highest, when the average window is 8 and 16 quarters, respectively. If agents don’t know the exact details of the policy, inflation is most stable when the Fed averages inflation over longer periods. Outcomes are always better when the Fed reveals the specific details about the policy. Chapter 3 examines and critiques the literature surrounding interest on reserves (IOR). I examine early theories around the conduct of IOR. I then discuss how the implementation of IOR has differed from these theories, and, through a model of the fed funds market, I show how IOR reshaped the market for reserves. Finally, I analyze modern challenges of IOR in an ``abundant reserve'' regime.

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.

Since the last two decades, many countries around the world have gone through a significant transformation in monetary policy. Their central banks now set low and stable inflation as their ultimate target in the long run. The main components of the successful implementation of this inflation targeting are transparency and credibility, and their accomplishment will be judged by public in their expectations about future inflation. As a result, the central banks implement a set of modern monetary policy principles to improve their transparency and credibility, and one of those modern principles is the adoption of a monetary policy rule. In this study, we attempt to investigate the conduct of monetary policy under an inflation targeting framework and explore the role of public inflation expectations in the monetary policy rule. We develop an expectations-augmented Taylor rule model for monetary policy using public inflation expectations and core inflation data to replace the traditional output gap and actual inflation, respectively.

Inflation targeting has become an increasingly common monetary policy adopted in an effort to reach lower and more stable levels of inflation; however, the empirical benefits of inflation targeting are hard to conclusively identify. The theoretical benefits are derived from its characterization as a rule regime, yet inflation targeting can incorporate discretion. This paper investigates how much discretion inflation targeting allows by testing for a structural break in the Taylor rule. If adopting inflation targeting represents implementing a rule regime, then we expect to observe a structural break in the Taylor rule. If inflation targeting allows for considerable discretion, then we expect the coefficients to change at the will of the central bank. I consider three early inflation targeting countries: Australia, Canada, and New Zealand. I estimate the Taylor rule using both rolling regressions and a split sample approach. In general I find that inflation targeting allows for considerable discretion.

The theoretical framework of this research is based on a hybrid New Open Economy Macroeconomic (NOEM) model which explains monetary transmission channels using an intertemporal general equilibrium framework based on a definite welfare criterion of the representative optimizing household in an open economy setup. The theoretical model allows both producer currency and local currency pricing of the international profit maximizing firms in an imperfectly competitive market configuration and thus justifies the 'hybrid' connotation. Prior empirical literature indicate that in the face of 'pricing to market' (PTM) activities of international profit maximizing firms in the imperfectly competitive market, monetary policy has limited potentials for maintaining low and stable price inflation in a small open economy under flexible exchange rate regime. In this context, the Reserve Bank of New Zealand confronts a constant challenge meeting its agenda of maintaining the low and stable domestic inflation rate since the inception of 'inflation targeting' policy stance in 1989. However, henceforth RBNZ is quite successful in maintaining the low and stable domestic inflation rate. Thus it may be said without much reservation that monetary policy has so far attained its objective in New Zealand with the implication that conventional 'monetary transmission channels' have worked in accordance with theoretical predictions. This research has incorporated policy and non-policy macroeconomic variables of New Zealand and four of its most important trading partners suggested by the NOEM model and constructed a benchmark Vector Autoregressive (VAR) model suitable for the small open economy of New Zealand for empirical analyses. Monetary policy shocks are exactly identified using Choleski decomposition of the structural shocks. Thus it is assumed that RBNZ can observe price and output fluctuations at least within a quarter (due to quarterly data) and contemporaneously responds through an appropriate policy stance while the target variables show lagged responses. Consequently, empirical evidence is found in support of the conventional monetary transmission channels. More specifically, it is found that domestic output falls on impact of a restrictive monetary policy stance on the part of RBNZ. On the other hand, both nominal and real effective exchange rates appreciate on impact due to a positive innovation to the bank discount rate reflecting a tight monetary policy implemented by the RBNZ. Besides, both consumer and producer prices decline due to the monetary contraction, whereas producer prices show more responsiveness to the restrictive monetary policy action compared to consumer prices, supporting the predictions of prior literature. Regarding the relative importance of the sources of variations in output, prices and exchange rates; monetary policy has a moderate influence explaining the movements of these variables. However, monetary policy is observed to explain a relatively significant proportion of the variations in producer and consumer prices in New Zealand and thus supports the inflation targeting nature of the RBNZ. This observation is also found robust as innovations to producer and consumer prices explain most of the variations in New Zealand bank discount rate. On the other hand, 'world commodity price index' explains most of the output variations in New Zealand, reflecting its open small economy nature.

Since the early 1990s, an increasing number of central banks have adopted inflation targeting as the strategy to conduct their monetary policy. Most of the literature on this topic presupposes that the instrument of monetary policy should be the nominal interest rate. This dissertation revisits the instrument problem in the context of a small open economy that implements inflation targeting. It formulates a partial equilibrium monetary model that describes the inflation process. This model is used to analyze the interaction between the typical instruments of monetary policy, namely the nominal interest rate or a monetary aggregate, with particular exchange rate regimes. In an open economy, the issue is not what the best instrument to deliver the desired inflation rate is but, rather, what the best combination of a particular exchange rate arrangement and one of the two other policy instruments is. An analytical result is that inflation targeting is incompatible with a hard-peg exchange rate regime. The theoretical framework does not allow, however, a definitive answer about the most appropriate combination of policy instruments to reach a desired sustainable path for the inflation rate. Given that the choice of the optimum instrument is an empirical problem, the monetary model of inflation is estimated econometrically using annual data for the past 53 years for Costa Rica. The estimated parameters are used to compute expressions for the mean-squared error for the inflation rate under different policy instrument combinations. A ranking of the mean-squared errors shows that the instrument combination that minimizes the error in targeting a desired inflation rate, in the long run, is the nominal interest rate and a free exchange rate regime. The reason why, from the perspective of monetary policy, a free exchange rate regime is superior to other regimes is that the latter, in the presence of capital movements, requires some form of monetary sterilization, which in turn leads to debt accumulation. Eventually, this debt leads to central bank losses, which in the long run are a source of monetary expansion and thereby of inflationary pressures.

Despite the success of inflation tageting in the 1990s around the world, recognizing the weaknesses of inflation targeting, many have argued that more refinements are needed. When output is persistent, inflation targeting tends to have high long-run inflation volatility. So price-path targeting, which promises lower inflation volatility, can be considered as an alternative. However, I argue that an optimally chosen hybrid of inflation targeting and price-path targeting gives even lower inflation volatility. Another weakness of inflation targeting is that central bankers, when left to act under discretion, tend to create a bias toward output stabilization. Therefore, I argue that central bankers should be appropriately conservative, and the level of conservativeness depends on output persistence. Also, I show that there is a close relationship between central bankers' conservativeness and the horizon over which price level is brought back to the desired path. One of the important aspects of inflation targeting is that it is inherently forward-looking. So, this requires a good inflation forecast, such as trimmed mean estimators suggested here. I show several methods of finding these trimmed mean estimators of inflation, which are more efficient than headline CPI inflation. However, these suggestions and elaborations should be implemented together with measures to earn the public's trust, without which success cannot be guaranteed. That is, central banks need to find the right balance between performing monetary policy optimally and earning the public's trust.