Essays on Capital Flows and Monetary Policy

Big and important questions in international macroeconomics and monetary economics can be difficult to answer because the data we observe is often the result of the complex interactions and responses of many individuals. Given all these complex interactions identifying and empirically estimating the size of any one particular relationship can be very challenging. Recently macroeconomists have made considerable progress at answering some important and difficult questions using micro-data -- data with a considerable cross sectional component -- and identification tools more commonly used in microeconomics. This dissertation will focus on using empirical tools designed for analysis with a cross-section and use them to answer 3 important questions in monetary economics and international macroeconomics./nIn Chapter 1, "Causal Effects of Capital Inflows", I use micro data on mutual funds and their clients to estimate the effect capital inflows -- flows of savings across country borders -- have on subsequent macroeconomic outcomes in the countries receiving the savings. Capital flow movements into and out of a country seem to predict subsequent economic booms and recessions (respectively) in that country. However, the investors who select which country to invest in (and when) would like to send their savings to countries about to have economic booms and to avoid countries about to have recessions. Therefore, an important issue to address is to what extent this strong positive correlation reflects the forecasting abilities of investors and to what extent is this correlation reflects the influence receiving capital inflows directly has on economic outcomes./nTo identify the direct effect of capital flows on subsequent economic outcomes, I construct a shift-share instrument to focus on variation unsophisticated investors who save into mutual funds. The identification assumption here is that investors in mutual funds are not picking their mutual funds based on news about where that mutual fund invests. I present several tests validating this assumption and then show that capital inflows do indeed have large effects on the recipient country's economy./nIn Chapter 2 "Estimating the effects of central bank communications", ChaeWon Baek and I investigate the effects central bank communications have on economic outcomes over and above their policy choices. In particular, we focus on the effect of them releasing to the public of information and analysis about the economy in conjunction with an interest rate announcement. Estimating the effects of communications on policy outcomes empirically is difficult because the information component of communications is both extremely hard to measure and then to summarize./nWe develop a procedure to estimate this ``information effect'' of monetary policy by taking advantage of two features of the Bank of England's policy strategy: firstly, 4 times a year they choose a policy rate and provide a detailed Inflation Report with analysis supporting their policy decision and 8 other times a year they choose a policy rate with a short press release instead. Secondly, we note that the purpose of these Inflation Reports is to justify the policy change being made which suggests the information content being provided over time will be correlated with the size of the interest rate adjustment./nWe then compare empirically the dynamic responses to monetary policy changes when an Inflation Report is released to the periods when it is not released -- the difference tells us the effect that providing information to the market has on the effect of monetary policy. We find evidence for a sizeable information effect due to the release of an Inflation Report -- strong enough to flip the signs of monetary policy. This suggests that central banks can control how markets respond to their policy movements by varying the information provided to contextualize the policy changes./nIn Chapter 3 "The Effects of Monetary Policy on Bubbles", Yuriy Gorodnichenko and I classify a cross-section of S\&P500 stocks and U.S. regional house prices as exhibiting bubble-like behavior and then test to see if the assets we classify as in bubbles react differently to monetary policy shocks. We find that they fall by more than their non-bubble counterparts and often by large magnitudes. In response to a 1000 basis point policy tightening, we find that regions with house prices classified as in bubbles fall by at least 5 percentage points more than regions where housing markets are not classified as in bubbles and for stocks the difference is 20 percentage points -- equivalent to the 1-year volatility of the S\&P500. These declines peak approximately one to 2 years after the policy shock occurs. This suggests that policy suggestions for central banks to ``lean against the wind'' by raising interest rates following large asset price movements, can have a meaningful effect on these asset prices.

Advisor: Gorodnichenko, Yuriy