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An Estimated Small Open Economy Model of the Financial Accelerator

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  • Alejandro Justiniano
  • Selim Elekdag
  • Ivan Tchakarov

Abstract

This paper develops a small open economy model where entrepreneurs partially finance investment using foreign currency denominated debt subject to a risk premium above and beyond international interest rates. We use Bayesian estimation techniques to evaluate the importance of balance sheet vulnerabilities combined with the presence of the financial accelerator for emerging market countries. Using Korean data, we obtain an estimate for the external risk premium, indicating the importance of the financial accelerator and potential balance sheet vulnerabilities for macroeconomic fluctuations. Furthermore, our estimates of the Taylor rule imply a strong preference to smooth both exchange rate and interest rate fluctuations.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 05/44.

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Length: 27
Date of creation: 01 Mar 2005
Date of revision:
Handle: RePEc:imf:imfwpa:05/44

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Keywords: Financial sector; Exchange rates; Savings; Economic models; exchange rate; standard deviation; probability; equation; calibration; exchange rate fluctuations; real exchange rate; time series; exchange rate regime; probabilities; exchange rate policy; exchange rate depreciation; nominal exchange rate; random walk; correlation; equations; fixed exchange rate; markov chain; stochastic processes; statistic; sampling; standard deviations; computation; fixed exchange rate regime; alternative exchange rate; exchange rate flexibility; linear time; flexible exchange rate; general equilibrium model; nonlinear model; linear time trend; cumulative distribution function; exchange rate movements; dollar exchange rate; survey; general equilibrium models; covariance; gamma distributions; data analysis; estimation procedure; econometrics; real exchange rates; real exchange rate depreciation; functional form; exchange rate pass; fixed exchange rates; flexible exchange rate regime; calibrations; probability models; bayesian analysis;

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References

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  1. Kollmann, Robert, 2002. "Monetary policy rules in the open economy: effects on welfare and business cycles," Journal of Monetary Economics, Elsevier, Elsevier, vol. 49(5), pages 989-1015, July.
  2. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
  3. V.V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2000. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," NBER Working Papers 7869, National Bureau of Economic Research, Inc.
  4. Michael B. Devereux & Philip R. Lane & Juanyi Xu, 2006. "Exchange Rates and Monetary Policy in Emerging Market Economies," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 116(511), pages 478-506, 04.
  5. Mark Gertler & Simon Gilchrist & Fabio Natalucci, 2001. "External constraints on monetary policy and the financial accelerator," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Mar.
  6. Aghion, Philippe & Bacchetta, Philippe & Banerjee, Abhijit, 2000. "Currency Crises and Monetary Policy in an Economy with Credit Constraints," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2529, C.E.P.R. Discussion Papers.
  7. Elekdag, Selim & Tchakarov, Ivan, 2007. "Balance sheets, exchange rate policy, and welfare," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 31(12), pages 3986-4015, December.
  8. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, Elsevier, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier.
  9. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  10. Juillard, Michel & Karam, Philippe & Laxton, Douglas & Pesenti, Paolo, 2006. "Welfare-based monetary policy rules in an estimated DSGE model of the US economy," Working Paper Series, European Central Bank 0613, European Central Bank.
  11. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange rates and financial fragility," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, Federal Reserve Bank of Kansas City, pages 329-368.
  12. Christopher A. Sims & Tao Zha, 2006. "Were There Regime Switches in U.S. Monetary Policy?," American Economic Review, American Economic Association, American Economic Association, vol. 96(1), pages 54-81, March.
  13. Luis Felipe Cespedes & Roberto Chang & Andres Velasco, 2000. "Balance Sheets and Exchange Rate Policy," NBER Working Papers 7840, National Bureau of Economic Research, Inc.
  14. Frank Schorfheide, 2000. "Loss function-based evaluation of DSGE models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 15(6), pages 645-670.
  15. Meier, André & Müller, Gernot J., 2005. "Fleshing out the monetary transmission mechanism: output composition and the role of financial frictions," Working Paper Series, European Central Bank 0500, European Central Bank.
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