Essays on Monetary Coordination, Exchange Rate Volatility And
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UNIVERSITY OF TORONTO ESSAYS ON MONETARY COORDINATION, EXCHANGE RATE VOLATILITY AND INTERFIRM NETWORKS A DISSERTATION SUBMITTED TO THE GRADUATE SCHOOL IN PARTIAL FULFILLMENT OF THE REQUIREMENTS for the degree DOCTOR OF PHILOSOPHY Field of Economics By Liu, Qing Department of Economics University of Toronto November 2008 c Copyright by Liu, Qing 2008 ° All Rights Reserved Library and Archives Bibliothèque et Canada Archives Canada Published Heritage Direction du Branch Patrimoine de l’édition 395 Wellington Street 395, rue Wellington Ottawa ON K1A 0N4 Ottawa ON K1A 0N4 Canada Canada Your file Votre référence ISBN: 978-0-494-58040-0 Our file Notre référence ISBN: 978-0-494-58040-0 NOTICE: AVIS: The author has granted a non- L’auteur a accordé une licence non exclusive exclusive license allowing Library and permettant à la Bibliothèque et Archives Archives Canada to reproduce, Canada de reproduire, publier, archiver, publish, archive, preserve, conserve, sauvegarder, conserver, transmettre au public communicate to the public by par télécommunication ou par l’Internet, prêter, telecommunication or on the Internet, distribuer et vendre des thèses partout dans le loan, distribute and sell theses monde, à des fins commerciales ou autres, sur worldwide, for commercial or non- support microforme, papier, électronique et/ou commercial purposes, in microform, autres formats. paper, electronic and/or any other formats. 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ABSTRACT ESSAYS ON MONETARY COORDINATION, EXCHANGE RATE VOLATILITY AND INTERFIRM NETWORKS Liu, Qing Doctor of Philosophy Department of Economics University of Toronto, 2008 This dissertation consists of three independent essays in Macroeconomics. The first essay analyzes monetary coordination between currency areas. It is shown that search frictions can generate the deviations from the law of one price and that each country is tempted to exploit these deviations by inflation. Monetary coordination eliminates the inefficiency caused by inflation. The welfare gains from coordination increase when the two economies become more integrated. In contrast to traditional models, the need for coordination exists even after each country is allowed to directly tax foreign holdings of its currency. The second essay studies the behavior of exchange rates in an environment with search fric- tions. In contrast to traditional models, even without any nominal rigidity, the model can generate enough volatility of exchange rates found in the data. The changes in the behavior of exchange rates under different regimes are also examined in this essay. The model shows a sharp increase in the volatility of exchange rates when moving from a pegged to a floating exchange regime, ii while there is no such systematic change in fluctuations of output or consumption. Moreover, the co-movements of output and consumption across countries are higher under a fixed rate regime than under a flexible rate regime. These results are consistent with empirical findings. The final essay focuses on the competition between groups of allied firms. In the essay we propose a model of group fitness and develop an approach to evaluate the fitness of groups and the utility of their member firms. A group has high fitness if member firms have four features: (i) high capacity, (ii) being embedded in dense relationships, (iii) holding complementary resources and (iv) having limited competition and conflict. We illustrate the effectiveness of our model and methodology by applying it to the airline groups between 1997 and 2002. By examining what really happened to the airline groups afterwards, we found that the predictions based on the comparison between the fitness scores of actual groups formed and those of the corresponding population constructed are reasonably accurate, and that the implications based on the ranking of individual firm utility within each group are generally supported. iii Acknowledgements No words alone can express my deep gratitude to Professor Shouyong Shi, my dissertation advisor, who is an influential mentor to me, inspiring me constantly in all these years and giving me numerous helpful suggestions and comments on my research. His continuous support and endless inspiration are simply essential for the successful completion of this work. I am more than fortunate to have him as my thesis supervisor. I am also indebted to many people at University of Toronto: Professor Xiaodong Zhu and Miquel Faig for being generous with their time and agreeing to serve on my thesis committee; Professor Michael Devereux, Margarida Duarte, Michelle Alexopoulos, Gueorgui Kambourov and Diego Restuccia for their helpful comments and suggestions; Joel Baum and Brian Silverman for their guidance on the third essay; Terry Amburgey, Andrew Delios, Mara Lederman, Stan X. Li, Joanne Oxley and Olav Sorenson for their valuable comments. The first essay in this thesis (Chapter 1) is a joint work with Shouyong Shi, and we would like to gratefully acknowledge the financial support from the Social Sciences and Humanities Research Council of Canada and from the Bank of Canada Fellowship. The opinion expressed in the thesis is the authors’ own and it does not represent the view of the Bank of Canada. The third essay (Chapter 3) is a joint work with Yanfei Zhao. iv Contents ABSTRACT ii Acknowledgements iv List of Tables vii List of Figures viii Introduction 1 Chapter 1. Currency Areas and Monetary Coordination 6 1.1. Introduction 6 1.2. The Model 11 1.3. Equilibrium 21 1.4. Integrated Economy 29 1.5. Optimal Monetary Policy 34 1.6. World Economy without Fully Integrated Markets 39 1.7. Directly Taxing Foreign Use of a Currency 43 1.8. Endogenous Allocation of Sellers 46 1.9. Conclusion 48 Chapter 2. The Volatility of Exchange Rates in a Search Model 50 2.1. Introduction 50 2.2. The Model 57 v 2.3. Linearized Dynamic System 69 2.4. Calibration 81 2.5. Results 84 2.6. Conclusion 93 Chapter 3. A Dynamic Evaluation of Interfirm Group Fitness in the Global Airline Industry 96 3.1. Introduction 96 3.2. Groups: Concept and Evidence in the Global Airline Industry 99 3.3. Toward a Theory of Interfirm Group Fitness 101 3.4. Quantitative Analysis 111 3.5. Conclusion 124 References 136 Appendix A. Appendix to Chapter 1 143 A.1. Proof of Lemma 1 and the Derivations for (1.25) and (1.26) 143 A.2. Proofs for Section 1.4 145 A.3. Proofs for Section 1.5 148 A.4. Supplementary Appendix 150 Appendix B. Appendix to Chapter 2 151 B.1. Log-linearized System 151 B.2. Solution Technique1 154 1Note that some of the symbols used here do not necessarily have the same meanings as the ones used in the text. vi List of Tables 1.1 Trade matches and trading quantities in currency area k 15 2.1 Trading arrangements and trade matches in the goods market 60 2.2 Simulated moments in the benchmark model 85 2.3 Simulated moments in a CIA model 90 2.4 Simulated results in fixed and flexible rate regimes 92 3.1 Factor Identification Based On Field Study 128 3.2 Airline Groups 1997 (Actual groups formed) 128 3.3 Airline Groups 1998 (Actual groups formed) 128 3.4 Airline Groups 1999 (Actual groups formed) 129 3.5 Airline Groups 2000 (Actual groups formed) 129 3.6 Airline Groups 2001 (Actual groups formed) 130 3.7 Airline Groups 2002 (Actual groups formed) 130 3.8 Percentile of Actual Group Fitness Scores 130 vii List of Figures 1.1 Country 1’s welfare W1 as a function of γ1 41 1.2 Effects of γ1 on country 1’s welfare and its composition 41 1.3 Nash equilibrium money growth at different s 42 1.4 Optimal tax τ 1 as a function of τ 2 44 1.5 Optimal money growth γ1 as a function of τ 2 45 2.1 Timing of Events 62 2.2 Volatility of the real exchange rate at different value of T0 89 3.1 Frequency of Factor Mentions 131 3.2 Qualiflyer Group Fitness 132 3.3 Qualiflyer Firm Utility 132 3.4 Star Alliance Group Fitness 133 3.5 Star Alliance Firm Utility 133 3.6 Atlantic Excellence Group Fitness 134 3.7 Atlantic Excellence Firm Utility 134 3.8 SkyTeam Group Fitness 135 3.9 SkyTeam Firm Utility 135 viii Introduction This thesis consists of three independent essays in Macroeconomics. In the first essay, we investigate the need for monetary coordination between currency areas in an environment with search frictions. The second essay focuses on the dynamics of exchange rates and thus goes beyond the steady-state analysis that explains only the behavior of exchange rates. The final essay studies interfirm networks and evaluates the interfirm group fitness in the global airline industry. Each essay is presented as a separate chapter in the thesis. Whether countries should coordinate their monetary policy has been an important issue in international economics and in policy debate. Given the increase in trade flows across countries, this subject becomes more important and more interesting.