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What Drives Business Cycles in a Small Open Economy with a Fixed Exchange Rate?

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Author Info
Niels Arne Dam (Institute of Economics, University of Copenhagen)
Jesper Gregers Linaa (Institute of Economics, University of Copenhagen)

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Abstract

We decompose the Danish business cycle into ten structural shocks using an open-economy DSGE model with infrequent determination of prices and wages which we estimate with Bayesian techniques. Consistent with the Danish monetary policy regime, we formulate an imperfect peg on the foreign exchange rate and analyse the resulting monetary transmission mechanism. We find that the Danish business cycle is dominated by stochastic movements in the labour supply in the long term, while demand shocks play a major role in the short term. Remarkably, the role of technology is negligible, and foreign factors only contribute little to the Danish business cycle, especially in the long term. With respect to the estimation, we generally find believable estimates although the degree of price stickiness is remarkably high.

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Publisher Info
Paper provided by Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics in its series EPRU Working Paper Series with number 05-02.

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Length: 30 pages
Date of creation: Mar 2005
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Handle: RePEc:kud:epruwp:05-02

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Related research
Keywords: open economy; peg; business cycles; Bayesian estimation;

Find related papers by JEL classification:
E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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  3. Paul R. Bergin, 2004. "How Well Can the New Open Economy Macroeconomics Explain the Exchange Rate and Current Account?," NBER Working Papers 10356, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Lawrence J. Christiano & Martin Eichenbaum & Robert Vigfusson, 2004. "The Response of Hours to a Technology Shock: Evidence Based on Direct Measures of Technology," NBER Working Papers 10254, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Lane, Philip R., 2001. "The new open economy macroeconomics: a survey," Journal of International Economics, Elsevier, vol. 54(2), pages 235-266, August. [Downloadable!] (restricted)
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  7. Pau Rabanal & Jordi Galí, 2005. "Technology Shocks and Aggregate Fluctuations: How Well Does the RBC Model Fit Postwar U.S. Data?," IMF Working Papers 04/234, International Monetary Fund. [Downloadable!]
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  8. Sims, Christopher A, 2002. "Solving Linear Rational Expectations Models," Computational Economics, Springer, vol. 20(1-2), pages 1-20, October. [Downloadable!]
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  9. McCallum, Bennett T & Nelson, Edward, 2000. "Monetary Policy for an Open Economy: An Alternative Framework with Optimizing Agents and Sticky Prices," Oxford Review of Economic Policy, Oxford University Press, vol. 16(4), pages 74-91, Winter.
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  10. John Geweke, 1999. "Computational Experiments and Reality," Computing in Economics and Finance 1999 401, Society for Computational Economics.
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  12. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, 09. [Downloadable!] (restricted)
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  13. Gali, Jordi & Gertler, Mark & Lopez-Salido, J. David, 2001. "European inflation dynamics," European Economic Review, Elsevier, vol. 45(7), pages 1237-1270. [Downloadable!] (restricted)
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  14. Kollmann, Robert, 2001. "Explaining international comovements of output and asset returns: The role of money and nominal rigidities," Journal of Economic Dynamics and Control, Elsevier, vol. 25(10), pages 1547-1583, October. [Downloadable!] (restricted)
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  17. Schmitt-Grohe, Stephanie & Uribe, Martin, 2003. "Closing small open economy models," Journal of International Economics, Elsevier, vol. 61(1), pages 163-185, October. [Downloadable!] (restricted)
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  18. McCallum, Bennett T. & Nelson, Edward, 1999. "Nominal income targeting in an open-economy optimizing model," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 553-578, June. [Downloadable!] (restricted)
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  19. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," NBER Working Papers 8403, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  20. Ellen R. McGrattan, 2004. "Comment on Gali and Rabanal's "Technology shocks and aggregate fluctuations: how well does the RBC model fit postwar U.S. data?"," Staff Report 338, Federal Reserve Bank of Minneapolis. [Downloadable!]
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