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A Small Open Economy DSGE Model for Pakistan

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  • Haider, Adnan
  • Khan, Safdar Ullah

Abstract

This paper estimates a small open economy Dynamic Stochastic General Equilibrium (DSGE) model for Pakistan using Bayesian simulation approach. Model setup is based on new Keynesian framework, characterized by nominal rigidity in prices with habit formation in household’s consumption. The core objective is to study whether an estimated small open economy DSGE model provides a realistic behavior about the structure Pakistan economy with fully articulated description of the monetary policy transmission mechanism vis-à-vis domestic firm’s price setting behavior. To do so, we analyze the impulse responses of key macro variables; domestic inflation, imported inflation, output, consumption, interest rate, exchange rate, term of trade to different structural/exogenous shocks. From several interesting results, few are; (a) high inflation in Pakistan do not hit domestic consumption significantly; (b) Central bank of Pakistan responds to high inflation by increasing the policy rate by 100 to 200 bps; (c) exchange rate appreciates in both the cases of high domestic and imported inflation; (d) tight monetary policy stance helps to curb domestic inflation as well as imported inflation but appreciates exchange rate significantly (f) pass through of exchange rate to domestic inflation is very low; finally parameter value of domestic price stickiness shows that around 24 percent domestic firms do not re-optimize their prices which implies averaged price contract is about two quarters.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 12977.

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Date of creation: 06 Nov 2008
Date of revision: 17 Jan 2009
Handle: RePEc:pra:mprapa:12977

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Keywords: New-Keynesian economics; open economy DSGE models; nominal rigidities; monetary policy transmission mechanism; Bayesian Approach;

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  1. Camilo E Tovar, 2005. "The mechanics of devaluations and the output response in a DSGE model: how relevant is the balance sheet effect?," BIS Working Papers 192, Bank for International Settlements.
  2. Justiniano, Alejandro & Preston, Bruce, 2010. "Can structural small open-economy models account for the influence of foreign disturbances?," Journal of International Economics, Elsevier, vol. 81(1), pages 61-74, May.
  3. Francisco J. Ruge-Murcia, 2004. "Methods to Estimate Dynamic Stochastic General Equilibrium Models," 2004 Meeting Papers 83, Society for Economic Dynamics.
  4. Adolfson, Malin & Laséen, Stefan & Lindé, Jesper & Villani, Mattias, 2005. "Bayesian Estimation of an Open Economy DSGE Model with Incomplete Pass-Through," Working Paper Series 179, Sveriges Riksbank (Central Bank of Sweden).
  5. Peter N. Ireland, 2002. "Technology Shocks in the New Keynesian Model," Boston College Working Papers in Economics 536, Boston College Department of Economics.
  6. Richard Clarida & Mark Gertler, 1996. "How the Bundesbank Conducts Monetary Policy," NBER Working Papers 5581, National Bureau of Economic Research, Inc.
  7. Montoro Llamosas, Carlos, 2005. "Dolarización Parcial," Revista Moneda, Banco Central de Reserva del Perú, issue 131, pages 5-9.
  8. Jaromir Benes & Tibor Hledik & Michael Kumhof & David Vavra, 2005. "An Economy in Transition and DSGE: What the Czech National Bank’s New Projection Model Needs," Working Papers 2005/12, Czech National Bank, Research Department.
  9. Marcos R. de Castro & Solange N. Gouvea & André Minella & Rafael C. dos Santos & Nelson F. Souza-Sobrinho, 2011. "SAMBA: Stochastic Analytical Model with a Bayesian Approach," Working Papers Series 239, Central Bank of Brazil, Research Department.
  10. Sumru Altug, 1986. "Time to build and aggregate fluctuations: some new evidence," Working Papers 277, Federal Reserve Bank of Minneapolis.
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Cited by:
  1. Haider, Adnan & Jan, Asad & Hyder, Kalim, 2012. "On the (IR) Relevance of Monetary Aggregate Targeting in Pakistan: An Eclectic View," MPRA Paper 43422, University Library of Munich, Germany.
  2. Ahmed, Shahzad & Pasha, Farooq, 2014. "The Role of Money in Explaining Business Cycles for a Developing Economy: The Case of Pakistan," MPRA Paper 55262, University Library of Munich, Germany, revised 11 Apr 2014.
  3. Hassan, Rubina & Shahzad, Mirza Muhammad, 2011. "A macroeconometric framework for monetary policy evaluation: A case study of Pakistan," Economic Modelling, Elsevier, vol. 28(1-2), pages 118-137, January.

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