Essays on integrated macro policy frameworks in small open economies

This thesis comprises three essays exploring the design and implications of integrated macro policy frameworks (IPFs) in small open economies, particularly under financial vulnerability, nominal rigidities, and policy credibility challenges. In these essays, the dissertation develops dynamic stochastic general equilibrium (DSGE) models tailored to emerging market contexts, where capital flows, external shocks, and policy tradeoffs play critical roles in macroeconomic stabilization. Through theoretical modeling, quantitative calibration, and policy analysis, the thesis investigates how monetary, fiscal, macroprudential, and capital flow management tools interact within a unified policy framework and assesses the macroeconomic stabilization outcomes of various policy configurations. Following a general introduction in Chapter I, Chapter II introduces a small open economy DSGE model to quantify the tradeoffs involved in the joint use of monetary policy, foreign exchange intervention (FXI), and capital flow management (CFM) tools. The model incorporates a range of empirically relevant frictions for emerging economies, including financial sector vulnerabilities, limited foreign exchange market depth, and fiscal rigidity. The novel contribution of this chapter lies in integrating fiscal dominance into the IPF framework. This friction alters the effectiveness of conventional monetary policy and necessitates using alternative tools to stabilize output and inflation. Simulation results reveal that FXI and CFM tools can significantly enhance the effectiveness of monetary policy, especially under binding fiscal constraints, by mitigating exchange rate volatility and dampening the transmission of capital flow shocks. Chapter III extends the baseline framework by explicitly modeling the role of policy credibility in shaping the effectiveness of integrated policy tools. It includes an endogenous credibility mechanism, which allows agents to learn about the policymaker's preferences and constraints using Bayesian updating and Kalman filtering. The analysis demonstrates that imperfect credibility amplifies the macroeconomic effects of shocks iv and undermines the stabilizing role of monetary policy. However, credibility-enhancing mechanisms -such as transparent, rule-based FXI policies- can offset these effects and restore policy effectiveness to an extent. The chapter provides a quantitative comparison of different FXI rules, emphasizing how their interactions with different levels of policy credibility influence expectations and macroeconomic volatility. Chapter IV complements the first two chapters by providing a comprehensive theoretical and empirical overview of integrated macro policy frameworks. It revisits the Mundell-Fleming trilemma in the presence of financial frictions and argues for the relevance of policy integration in macroeconomic stabilization. Based on Basu et al. (2020), the chapter summarizes how different combinations of IPF tools perform under alternative shock scenarios. The chapter also presents empirical evidence regarding the effectiveness of standalone versus joint use of IPF instruments. The findings suggest that simultaneous deployment of monetary, macroprudential, and capital flow measures can achieve superior stabilization outcomes, particularly in economies with high financial openness.