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on Open MacroEconomics |
| By: | Deming Luo (Department of Economics, Carleton University); Stephen Ferris (Department of Economics, Carleton University) |
| Abstract: | The paper addresses whether or not the exchange rate or some other dimension of the external side of the economy should form an integral part of the monetary rule for a small open economy (SOE) in which the central bank faces data deficiencies. Under a number of information scenarios, the model’s simulations suggest that some reflection of the external environment facing the SOE—either the real exchange rate gap and/or the law of one price gap—is needed to improve monetary policy performance. When the money rule includes both interest rate smoothing and the real exchange rate (or law of one price gap), the relative welfare gain from their inclusion increases as the monetary authorities loses access to more current and reliable information. |
| Keywords: | New Keynesian small open economy model, exchange rate pass through, optimal simple money rules, stochastic general equilibrium model. |
| Date: | 2008–08–01 |
| URL: | http://d.repec.org/n?u=RePEc:car:carecp:08-03&r=opm |
| By: | Alejandro Justiniano; Bruce Preston |
| Abstract: | This paper demonstrates that an estimated, structural, small open economy model of the Canadian economy cannot account for the substantial influence of foreign-sourced disturbances identified in numerous reduced-form studies. The benchmark model assumes uncorrelated shocks across countries and implies that U.S. shocks account for less than 3 percent of the variability observed in several Canadian series, at all forecast horizons. Accordingly, model-implied cross-correlation functions between Canada and U.S. are essentially zero. Both findings are at odds with the data. A specification that assumes correlated cross-country shocks partially resolves this discrepancy, but still falls well short of matching reduced-form evidence. |
| JEL: | F41 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:14547&r=opm |
| By: | Jarkko Jääskelä (Reserve Bank of Australia); Kristoffer Nimark (Reserve Bank of Australia) |
| Abstract: | We estimate an open economy dynamic stochastic general equilibrium (DSGE) model of Australia with a number of shocks, frictions and rigidities, matching a large number of observable time series. We find that both foreign and domestic shocks are important drivers of the Australian business cycle. We also find that the initial impact on inflation of an increase in demand for Australian commodities is negative, due to an improvement in the real exchange rate, though there is a persistent positive effect on inflation that dominates at longer horizons. |
| Keywords: | monetary policy |
| JEL: | C11 E40 E52 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:rba:rbardp:rdp2008-07&r=opm |
| By: | Bukhari, Syed Adnan Haider Ali Shah; Khan, Safdar Ullah |
| Abstract: | This paper estimates a small open economy Dynamic Stochastic General Equilibrium (DSGE) model for Pakistan using Bayesian simulation approach. Model setup is based on new Keynesian framework, characterized by nominal rigidity in prices with habit formation in household’s consumption. The core objective is to study whether an estimated small open economy DSGE model provides a realistic behavior about the structure Pakistan economy with fully articulated description of the monetary policy transmission mechanism vis-à-vis domestic firm’s price setting behavior. To do so, we analyze the impulse responses of key macro variables; domestic inflation, imported inflation, output, consumption, interest rate, exchange rate, term of trade to different structural/exogenous shocks. From several interesting results, few are; (a) high inflation in Pakistan do not hit domestic consumption significantly; (b) Central bank of Pakistan responds to high inflation by increasing the policy rate by 100 to 200 bps; (c) exchange rate appreciates in both the cases of high domestic and imported inflation; (d) tight monetary policy stance helps to curb domestic inflation as well as imported inflation but appreciates exchange rate significantly (f) pass through of exchange rate to domestic inflation is very low; finally parameter value of domestic price stickiness shows that around 24 percent domestic firms do not re-optimize their prices which implies averaged price contract is about two quarters. |
| Keywords: | New-Keynesian economics; open economy DSGE models; nominal rigidities; monetary policy transmission mechanism; Bayesian Approach |
| JEL: | F37 E32 E52 F47 E47 |
| Date: | 2008–11–18 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:12184&r=opm |
| By: | Joseph Francois; Clinton R. Shiells (International Monetary Fund & Joint Vienna Institute) |
| Abstract: | We offer a duality-based methodology for incorporating multi-sector effects of international trade into open economy macroeconomic models, developing the concepts of the dynamic factor price equalization set and the integrated intertemporal equilibrium. Under this approach, the aggregate production function depends on output prices and factor endowment stocks. It preserves all of the structure of a standard GDP function from the trade theory literature. In a two-country version of the model considered below, we examine the properties of the dynamic factor price equalization set. If the global economy is initially outside of this set, the equations of motion will pull the economy back into this set. Inside the dynamic FPE set, factor prices are equalized internationally, and with identical tastes and technology, the economy can be regarded as a fully integrated world equilibrium in a dynamic sense (the integrated intertemporal equilibrium). In this equilibrium, all of the standard properties of a closed economy one-sector neoclassical growth model hold, ruling out cycles and chaos, and allowing us to characterize the evolution of international inequality and the persistence of productivity and endowment shocks. Working from the integrated intertemporal equilibrium, we identify properties of persistence linked to inequality and real economic shocks. Cross-country differences in per capita incomes and wealth, and the factor content of trading patterns, may persist over time and even into the new steady state. This provides yet another reason why we might observe lack of income convergence internationally. In addition, real shocks in one country may be transmitted to the other country through factor markets and product prices, and may have persistent effects into the steady-state as well. The model can also generate an endogenous Balassa-Samuelson effect. |
| Keywords: | Neoclassical Models of Trade, Economic Growth of Open Economies, Cross- Country Output Convergence |
| JEL: | F41 O47 F11 F43 |
| Date: | 2008–11 |
| URL: | http://d.repec.org/n?u=RePEc:jku:econwp:2008_20&r=opm |
| By: | Roman Frydman (New York University); Michael D. Goldberg (University of New Hampshire); Søren Johansen (Department of Economics, University of Copenhagen); Katarina Juselius (Department of Economics, University of Copenhagen) |
| Abstract: | Asset prices undergo long swings that revolve around benchmark levels. In currency markets, fluctuations involve real exchange rates that are highly persistent and that move in near-parallel fashion with nominal rates. The inability to explain these two regularities with one model has been called the "Purchasing Power Parity puzzle". In this paper, we trace the puzzle to exchange rate modelers' use of the "Rational Expectations Hypothesis". We show that once imperfect knowledge is recognized, a monetary model is able to account for the puzzle, as well as other salient features of the data, including the long-swings behavior of exchange rates. |
| Keywords: | PPP puzzle; long swings; imperfect knowledge; rational expectations hypothesis |
| JEL: | F31 F41 G15 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:kud:kuiedp:0831&r=opm |
| By: | Pasricha, Gurnain Kaur |
| Abstract: | This paper explores the implications of financial repression, specifically, imperfect competition in the financial sector and capital controls for equilibrium interest rates and current account imbalances; and the implications of liberalization. I find that (1) interest differentials between home and foreign markets exist and are higher the fewer the number of domestic financial institutions (2) liberalization of the domestic financial sector - i.e. increasing the number of players - exacerbates current account imbalances in growing economies and reduces revenues from repression (3) revenues from financial repression decline when capital controls become porous (which may be a consequnce of trade liberalization), making liberalization of domestic financial sector more palatable to the domestic governments. An empirical exercise validates several predictions of the model. |
| Keywords: | Financial Repression; Capital Controls; Imperfect Competition in Financial Markets; Domestic Financial Liberalization; Interest Differentials |
| JEL: | F4 F32 D43 |
| Date: | 2008–12–11 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:12125&r=opm |