Thesis Thursdays: Colin Gray
My paper provides a missing piece to this theory by illustrating how the actions of the Federal Reserve affect the actions of central banks in foreign countries. Noting a dearth of research on the topic of how central bank behavior transmits across borders, I construct a rational expectations model to illustrate how a deviation from monetary policy rules by the Federal Reserve would lead to a deviation from similar monetary policy rules in other countries, as well as an accumulation of foreign reserves. I use panel regression techniques to show how the effects hold historically, and consider in further detail how this theory may explain the European Central Bank’s deviation from monetary policy rules in the early 2000’s. Indeed, a deviation from monetary policy rules by the Federal Reserve tends to cause a similar deviation in other countries, as well as a build-up of foreign reserves, which would be reinvested in the U.S. This conclusion, backed both by the model and data in my paper, suggests that the low Federal Funds rate in the early 2000’s may have had much deeper, and indeed more catastrophic, consequences than were previously recognized, and may have played a central role in the mid-2000’s bubbles and the crash that followed.
Colin Gray ’12 is a senior majoring in Economics.