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Alternative Monetary Regimes in a DSGE Model of a Small Open Economy with Two Sectors and Sticky Prices and Wages

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  • Guillermo J. Escudé

    ()
    (Central Bank of Argentina)

Abstract

This paper develops a dynamic stochastic general equilibrium (DSGE) model for a small open economy (SOE) that can be calibrated to simulate the macro dynamics of a semi-industrialized developing country like Argentina. We consider a multilateral non-commodity trade environment, with the USA and Europe as trade partners, and assume that the Law of One Price does not hold for the goods that the USA and Europe trade between them. We show that this makes the USA´s multilateral real exchange rate (MRER) a key fundamental for the SOE´s MRER, in addition to its terms of trade. The SOE produces and consumes exportable and non tradable goods using labor (and in the case of exportables, imports). There is a representative, perfectly competitive firm producing exportables and operating under perfectly flexible export and import prices. Monopolistic competition with price (wage) stickiness prevails for non-tradable firms (households). These set prices (wages) subject to a price/wage adjustment cost function. There coexist both forward and backward looking firms. The latter use a "rule of thumb" to change prices that gradually corrects their price to that of optimizing firms. Alternative monetary or foreign exchange policy rules, including a fixed exchange rate, inflation targeting under a pure float and inflation targeting under a managed float, complete the dynamic systems. The non-stochastic steady state is analyzed in detail for the alternative models and the log-linearized systems are obtained.

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Bibliographic Info

Article provided by Central Bank of Argentina, Economic Research Department in its journal Ensayos Económicos.

Volume (Year): 1 (2007)
Issue (Month): 49 (October - December)
Pages: 65-138

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Handle: RePEc:bcr:ensayo:v:1:y:2007:i:49:p:65-138

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Keywords: DSGE models; exchange rate policy; monetary policy; small open economy; sticky prices and wages;

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  9. Jordi Galí & Tommaso Monacelli, 2004. "Monetary policy and exchange rate volatility in a small open economy," Economics Working Papers 835, Department of Economics and Business, Universitat Pompeu Fabra.
  10. Lars E. O. Svensson, 2000. "Open-Economy Inflation Targeting," NBER Working Papers 6545, National Bureau of Economic Research, Inc.
  11. Katharine Neiss & Edward Nelson, 2002. "Inflation dynamics, marginal cost, and the output gap: evidence from three countries," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  12. Jeffery D. Amato, 2005. "The role of the natural rate of interest in monetary policy," BIS Working Papers 171, Bank for International Settlements.
  13. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
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