Monetary Policies in a Small Open Economy Model with Labor Mobility and Remittances
Abstract
Read the thesis at https://ink.library.smu.edu.sg/etd_coll/230. This paper presents a model of a small open economy that allows for international labor mobility, thereby endogenizing migrant transfers or remittances. The resulting model is calibrated to the Philippine economy, of which labor migration and remittance inflows are key forces that drive the economy’s growth. The model’s impulse response functions illustrate that the presence of these features generates a different set of dynamics from the standard small open economy model (without labor mobility). Depending on the source of the shock, labor mobility and remittances can either exacerbate or cushion the impact of the shock on the economy. A temporary and unanticipated rise in the world interest rate leads to a drop in aggregate output in the environment with labor mobility compared to one without. In contrast, an adverse terms-of-trade shock of the same nature affects output less severely in the case with labor mobility. Finally, a welfare cost comparison of different monetary regimes reveals that policies fostering flexible exchange rates bring about welfare gains relative to a baseline policy of inflation targeting that places a small weight on fixing the nominal exchange rate (otherwise known as hybrid flexible inflation targeting). In particular, pegging the monetary base proves to be welfare-superior to six other simple rules, namely: non-traded price inflation, price-level, strict inflation, hybrid flexible inflation, exchange-rate, and export-price targeting (of which the ranking follows the order of enumeration). The ranking is preserved when labor mobility and remittances are absent in the model.