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An Estimated Stochastic General Equilibrium Model with Partial Dollarization: A Bayesian Approach

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  • Paul Castillo
  • Carlos Montoro
  • Vicente Tuesta

Abstract

This paper develops and estimates a dynamic stochastic general equilibrium New Keynesian model of a small open economy with partial dollarization. We use Bayesian techniques and Peruvian data to evaluate two forms of dollarization: currency substitution (CS) and price dollarization (PD). Our empirical results are as follows. First, we find that the two forms of partial dollarization are important to explain the Peruvian data. Second, models with both forms of dollarization dominate models without dollarization. Third, a counter-factual exercise shows that by eliminating both forms of partial dollarization the response of both output and consumption to a monetary policy shock doubles, making the interest rate channel of monetary policy more effective. Forth, based on the variance decomposition of the preferred model (with CS and PD), we find that demand type shocks explain almost all the fluctuation in CPI inflation, being the monetary shock the most important (39 percent). Remarkably, foreign disturbances account for 34 percent of output fluctuations.

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Bibliographic Info

Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 381.

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Date of creation: Dec 2006
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Handle: RePEc:chb:bcchwp:381

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References

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  1. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Closing Small Open Economy Models," Departmental Working Papers, Rutgers University, Department of Economics 200115, Rutgers University, Department of Economics.
  2. Jorge Selaive & Vicente Tuesta, 2003. "Net Foreign Assets And Imperfect Financial Integration: An Empirical Approach," Working Papers Central Bank of Chile, Central Bank of Chile 252, Central Bank of Chile.
  3. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper 0107, Federal Reserve Bank of Cleveland.
  4. Pierpaolo Benigno & Michael Woodford, 2004. "Inflation Stabilization and Welfare: The Case of a Distorted Steady State," NBER Working Papers 10838, National Bureau of Economic Research, Inc.
  5. Alejandro Justiniano & Bruce Preston, 2009. "Can structural small open economy models account for the influence of foreign disturbances?," Working Paper Series, Federal Reserve Bank of Chicago WP-09-19, Federal Reserve Bank of Chicago.
  6. Rabanal, Pau & Rubio-Ramirez, Juan F., 2005. "Comparing New Keynesian models of the business cycle: A Bayesian approach," Journal of Monetary Economics, Elsevier, vol. 52(6), pages 1151-1166, September.
  7. Olivier J. Blanchard & Jordi Galí, 2005. "Real wage rigidities and the New Keynesian model," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
  8. Castillo, Paul & Montoro, Carlos & Tuesta, Vicente, 2009. "Un modelo de equilibrio general con dolarización para la economía peruana," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 17, pages 9-50.
  9. Castillo, Paul & Montoro, Carlos & Tuesta, Vicente, 2007. "Hechos estilizados de la economía peruana," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 14, pages 33-75.
  10. John Y. Campbell & John H. Cochrane, 1994. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," CRSP working papers 412, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  11. Adolfson, Malin & Laseen, Stefan & Linde, Jesper & Villani, Mattias, 2007. "Bayesian estimation of an open economy DSGE model with incomplete pass-through," Journal of International Economics, Elsevier, vol. 72(2), pages 481-511, July.
  12. De Paoli, Bianca, 2009. "Monetary policy and welfare in a small open economy," Journal of International Economics, Elsevier, vol. 77(1), pages 11-22, February.
  13. Rabanal, Pau & Tuesta, Vicente, 2010. "Euro-dollar real exchange rate dynamics in an estimated two-country model: An assessment," Journal of Economic Dynamics and Control, Elsevier, vol. 34(4), pages 780-797, April.
  14. Paúl Castillo & Alberto Humala & Vicente Tuesta, 2012. "Regime shifts and inflation uncertainty in Peru," Journal of Applied Economics, Universidad del CEMA, vol. 0, pages 71-87, May.
  15. Kollmann, Robert, 2002. "Monetary policy rules in the open economy: effects on welfare and business cycles," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 989-1015, July.
  16. Pierpaolo Benigno, 2008. "Price stability with imperfect financial integration," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
  17. Nicoletta Batini & Paul Levine & Joseph Pearlman, 2008. "Optimal Exchange Rate Stabilization in a Dollarized Economy with Inflation Targets," Working Papers, Banco Central de Reserva del Perú 2008-004, Banco Central de Reserva del Perú.
  18. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  19. Rabanal, Pau & Tuesta Reátegui, Vicente, 2006. "Euro-Dollar Real Exchange Rate Dynamics in an Estimated Two-Country Model: What is Important and What is Not," CEPR Discussion Papers 5957, C.E.P.R. Discussion Papers.
  20. Humala, Alberto, 2007. "Expectativas de depreciación y diferencial de tasas de interés: ¿Hay regímenes cambiantes? El caso de Perú," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 14, pages 77-106.
  21. Fernandez-Villaverde, Jesus & Francisco Rubio-Ramirez, Juan, 2004. "Comparing dynamic equilibrium models to data: a Bayesian approach," Journal of Econometrics, Elsevier, vol. 123(1), pages 153-187, November.
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Citations

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Cited by:
  1. Castillo, Paul & Montoro, Carlos & Tuesta, Vicente, 2007. "Hechos estilizados de la economía peruana," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 14, pages 33-75.
  2. Carlos Garcia, 2012. "Why Does Monetary Policy Respond to the Real Exchange Rate in Small Open Economies? A Bayesian Perspective," ILADES-Georgetown University Working Papers, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines inv287, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines.
  3. Winkelried, Diego, 2013. "Modelo de Proyección Trimestral del BCRP: Actualización y novedades," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 26, pages 9-60.
  4. Aliya Algozhina, 2012. "Monetary and Fiscal Policy Interactions in an Emerging Open Economy: a Non-Ricardian DSGE Approach," FIW Working Paper series 094, FIW, revised Dec 2012.
  5. Felices Guillermo & Tuesta Vicente, 2007. "Monetary Policy in Dual Currency Environment," Working Papers, Banco Central de Reserva del Perú 2007-006, Banco Central de Reserva del Perú.
  6. Levine, Paul & Pearlman, Joseph, 2011. "Monetary and Fiscal Policy in a DSGE Model of India," Working Papers 11/96, National Institute of Public Finance and Policy.
  7. Javier García-Cicco, 2010. "Estimating Models for Monetary Policy Analysis in Emerging Countries," Working Papers Central Bank of Chile, Central Bank of Chile 561, Central Bank of Chile.
  8. Javier García-Cicco, 2008. "Recent Developments in Monetary Policy Analysis for Emerging Countries," Ensayos Económicos, Central Bank of Argentina, Economic Research Department, Central Bank of Argentina, Economic Research Department, vol. 1(51), pages 123-142, April - S.
  9. Renzo Rossini & Marco Vega, 2008. "The monetary policy transmission mechanism under financial dollarisation: the case of Peru 1996-2006," BIS Papers chapters, in: Bank for International Settlements (ed.), Transmission mechanisms for monetary policy in emerging market economies, volume 35, pages 395-412 Bank for International Settlements.
  10. Salas, Jorge, 2011. "Estimación bayesiana de unmodelo de pequeña economía abierta con dolarización parcial," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 22, pages 41-62.
  11. Carlos Garcia & Wildo Gonzalez, 2014. "Why does monetary policy respond to the real exchange rate in small open economies? A Bayesian perspective," Empirical Economics, Springer, vol. 46(3), pages 789-825, May.
  12. Castillo, Paul & Rojas, Youel, 2014. "Terms of Trade and Total Factor Productivity: Empirical evidence from Latin American emerging markets," Working Papers, Banco Central de Reserva del Perú 2014-012, Banco Central de Reserva del Perú.

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