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Monetary Policy in Estimated Models of Small Open and Closed Economies

  • Ali Dib

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The author develops and estimates a quantitative dynamic-optimizing model of a small open economy (SOE) with domestic and import price stickiness and capital-adjustment costs. A monetary policy rule allows the central bank to systematically manage the short-term nominal interest rate in response to deviations of inflation, output, and money growth from their steadystate levels. The structural parameters of the SOE model, as well as those of a sticky-price model for a closed economy (CE), are estimated econometrically using data from Canada and the United States and a maximum-likelihood procedure with a Kalman filter. Estimation results show that the SOE and CE models lead to similar estimates for the Canadian economy. Furthermore, the effects of monetary policy shocks, and of other domestic shocks, generated in the SOE model are isomorphic to those generated in the CE model. Nevertheless, the forecast-error decomposition shows that the importance of domestic demand shocks is reduced by the introduction of foreign shocks.

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File URL: http://hdl.handle.net/10.1007/s11079-010-9173-1
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Article provided by Springer in its journal Open Economies Review.

Volume (Year): 22 (2011)
Issue (Month): 5 (November)
Pages: 769-796

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Handle: RePEc:kap:openec:v:22:y:2011:i:5:p:769-796
Contact details of provider: Web page: http://www.springerlink.com/link.asp?id=100323

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  1. Peter N. Ireland, 1999. "Sticky-Price Models of the Business Cycle: Specification and Stability," Boston College Working Papers in Economics 426, Boston College Department of Economics.
  2. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Closing Small Open Economy Models," Departmental Working Papers 200115, Rutgers University, Department of Economics.
  3. 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.
  4. Ali Dib & Mohamed Gammoudi & Kevin Moran, 2006. "Forecasting Canadian Time Series with the New Keynesian Model," Staff Working Papers 06-4, Bank of Canada.
  5. 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.
  6. Devereux, Michael B. & Engel, Charles, 2002. "Exchange rate pass-through, exchange rate volatility, and exchange rate disconnect," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 913-940, July.
  7. Peter N. Ireland, 2001. "Endogenous Money or Sticky Prices?," Boston College Working Papers in Economics 499, Boston College Department of Economics.
  8. Ali Dib, 2003. "An estimated Canadian DSGE model with nominal and real rigidities," Canadian Journal of Economics, Canadian Economics Association, vol. 36(4), pages 949-972, November.
  9. Richard Clarida & Jordi Gali & Mark Gertler, 2001. "Optimal Monetary Policy in Closed versus Open Economies: An Integrated Approach," NBER Working Papers 8604, National Bureau of Economic Research, Inc.
  10. McCallum, Bennett T. & Nelson, Edward, 1998. "Nominal Income Targeting in an Open-Economy Optimizing Model," Seminar Papers 644, Stockholm University, Institute for International Economic Studies.
  11. Smets, Frank & Wouters, Raf, 2002. "Openness, imperfect exchange rate pass-through and monetary policy," Working Paper Series 0128, European Central Bank.
  12. Robert Kollmann, 2002. "Monetary policy rules in the open economy: effects of welfare and business cycles," ULB Institutional Repository 2013/7628, ULB -- Universite Libre de Bruxelles.
  13. Nooman Rebei & Steven Ambler & Ali Dib, 2004. "Optimal Taylor Rules in an Estimated Model of a Small Open Economy," Econometric Society 2004 North American Summer Meetings 627, Econometric Society.
  14. Fabio Ghironi, 2000. "Towards New Open Economy Macroeconometrics," Boston College Working Papers in Economics 469, Boston College Department of Economics.
  15. Hafedh Bouakez, 2002. "Nominal Rigidity, Desired Markup Variations, and Real Exchange Rate Persistence," Staff Working Papers 02-26, Bank of Canada.
  16. Lane, P, 1999. "The New Open Economy Macroeconomics: A Survey," Trinity Economics Papers 993, Trinity College Dublin, Department of Economics.
  17. Dib, Ali, 2006. "Nominal rigidities and monetary policy in Canada," Journal of Macroeconomics, Elsevier, vol. 28(2), pages 303-325, June.
  18. Kollmann, Robert, 2001. "The exchange rate in a dynamic-optimizing business cycle model with nominal rigidities: a quantitative investigation," Journal of International Economics, Elsevier, vol. 55(2), pages 243-262, December.
  19. Francisco Covas & Yahong Zhang, 2008. "Price-Level versus Inflation Targeting with Financial Market Imperfections," Staff Working Papers 08-26, Bank of Canada.
  20. Kevin Clinton, 1998. "Canada-U.S. long-term interest differentials in the 1990s," Bank of Canada Review, Bank of Canada, vol. 1998(Spring), pages 17-38.
  21. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
  22. Alejandro Justiniano Espigares & Selim Elekdag & Ivan Tchakarov, 2005. "An Estimated Small Open Economy Model of the Financial Accelerator," IMF Working Papers 05/44, International Monetary Fund.
  23. David Bowman & Brian M. Doyle, 2003. "New Keynesian, open-economy models and their implications for monetary policy," International Finance Discussion Papers 762, Board of Governors of the Federal Reserve System (U.S.).
  24. Bouakez, Hafedh & Rebei, Nooman, 2008. "Has exchange rate pass-through really declined? Evidence from Canada," Journal of International Economics, Elsevier, vol. 75(2), pages 249-267, July.
  25. Jordi Galí & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 707-734.
  26. 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.
  27. Bergin, Paul R., 2003. "Putting the 'New Open Economy Macroeconomics' to a test," Journal of International Economics, Elsevier, vol. 60(1), pages 3-34, May.
  28. Ali Dib, 2002. "Nominal Rigidities and Monetary Policy in Canada Since 1981," Staff Working Papers 02-25, Bank of Canada.
  29. Jordi Gali & Tommaso Monacelli, 1999. "Optimal Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Boston College Working Papers in Economics 438, Boston College Department of Economics, revised 15 Nov 1999.
  30. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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