Monetary Policy Analysis in a Small Open Economy: A Dynamic Stochastic General Equilibrium Approach

Vitek, Francis (2006): Monetary Policy Analysis in a Small Open Economy: A Dynamic Stochastic General Equilibrium Approach.

Abstract

This paper develops and estimates a dynamic stochastic general equilibrium model of a small open economy which approximately accounts for the empirical evidence concerning the monetary transmission mechanism, as summarized by impulse response functions derived from an estimated structural vector autoregressive model, while dominating that structural vector autoregressive model in terms of predictive accuracy. The model features short run nominal price and wage rigidities generated by monopolistic competition and staggered reoptimization in output and labour markets. The resultant inertia in inflation and persistence in output is enhanced with other features such as habit persistence in consumption, adjustment costs in investment, and variable capital utilization. Incomplete exchange rate pass through is generated by monopolistic competition and staggered reoptimization in the import market. Cyclical components are modeled by linearizing equilibrium conditions around a stationary deterministic steady state equilibrium, while trend components are modeled as random walks while ensuring the existence of a well defined balanced growth path. Parameters and trend components are jointly estimated with a novel Bayesian full information maximum likelihood procedure.

• Item Type: MPRA Paper
• Language: English
• Keywords: Monetary policy analysis; Inflation targeting; Small open economy; Dynamic stochastic general equilibrium model; Monetary transmission mechanism; Forecast performance evaluation
• Subjects: C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C11 - Bayesian Analysis: General; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics; C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C13 - Estimation: General; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F47 - Forecasting and Simulation: Models and Applications; C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C32 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes ; State Space Models

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