Essays on Real Exchange Rates and Theoretical Monetary Aggregation

Abstract

This dissertation is a collection of three essays focused on real exchange rates and theoretical monetary aggregation. The first essay focused on the convergence of real exchange rates' idiosyncratic effects after isolating their common feature, which was caused by binary exchange rate numeraire. The evidence of convergence of idiosyncratic real exchange rates was mixed. The half-life of real exchange rates mean reverting period was considerably shorter than what was previously found in literature. The result was significantly shorter than "Rogoff's consensus" half-life which was 3- to 5-year. The second essay was to construct Divisia index for China following Barnett (1978, 1980). First, we probed the statistical discrepancy of the raw data provided by the People's Bank of China and proposed the appropriate forms that the authority has been published to extract the data of monetary assets' balances. Second, we adjusted the interest rates of China monetary assets to the annualized one-month holding period yields and further we used the yield curve adjustment method to subtract the term premium of monetary assets with different maturities. Third, we constructed the nominal Divisia index of Renminbi M2. The constructed Divisia M2 is seasonally unadjusted. In the third essay, the theoretical monetary aggregation was introduced to a new Keynesian Dynamic Stochastic General Equilibrium framework. It has been argued by Barnett and Chauvet (2011) and Barnett (2011) that a major source of inaccurate information within agents' information sets was the troublesome monetary aggregate data the Fed provided. Those data were inconsistent with elementary principles of aggregation theory over imperfect substitutes. By introducing Divisia monetary aggregation into a New Keynesian DSGE model, we showed that the prevailing simple-sum monetary aggregates violated decision optimality conditions and thereby distorted decisions. With a continuum of monetary assets and a monetary aggregate, we developed an internally coherent money-demand function, improving the understanding of the demand for "moneyness." The user-cost aggregate, which was dual to the monetary aggregate and was interpreted as the price of "moneyness," played the key role in our framework and was preferable to the interest rate aggregate or single interest rate most commonly used within such models. We proposed a monetary policy rule consistent with the model and then studied the impulse responses.