The impact of an unanticipated monetary shock in a small open economy with dollarization, factor price rigidities, and nontradeables is re-examined in an optimizing intertemporal general equilibrium model. The framework of an earlier study is extended to incorporate foreign real money balances into the repre-sentative agent's utility function and to account for the phenomenon of dollarization so characteristic of transition economies. The major finding is that in the event of small monetary shocks, the presence of dollarization does not alter the outcome that relates the sign of response of consumption, current account balance, and other macroeconomic variables to the difference between intertemporal and intratemporal elasticities of substitutions of the total consumption index. The solution also shows that the elasticity of intertemporal substitution of money services and the share of traded goods in total consumption - a proxy for openness of the economy - are the crucial parameters in determining the response and the possibility of overshooting of the model variables, with economic openness playing a stabilizing role for the econ-omy in the event of monetary shocks.
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Paper provided by Bank of Finland, Institute for Economies in Transition in its series BOFIT Discussion Papers with number
12/2000.
Length: 68 pages Date of creation: 23 Nov 2000 Date of revision: Handle: RePEc:hhs:bofitp:2000_012
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Find related papers by JEL classification: F31 - International Economics - - International Finance - - - Foreign Exchange F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation
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