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Monetary Policy, Informality and Business Cycle Fluctuations in a Developing Economy Vulnerable to External Shocks

Listed author(s):
  • Adnan Haider

    (Department of Economics and Finance, Institute of Business Administration, Karachi)

  • Musleh ud Din

    (Pakistan Institute of Development Economics, Islamabad)

  • Ejaz Ghani

    (Dean, Department of Economics, Pakistan Institute of Development Economics, Islamabad.)

This paper develops an open economy dynamic stochastic general equilibrium (DSGE) model based on New-Keynesian micro-foundations. Alongside standard features of emerging economies, such as a combination of producer and local currency pricing for exporters, foreign capital inflow in terms of foreign direct investment and oil imports, this model also incorporates informal labour and production sectors. This customisation intensifies the exposure of a developing economy to internal and external shocks in a manner consistent with the stylised facts of Business Cycle Fluctuations. We then focus on optimal monetary policy analysis by evaluating alternative interest rate rules and calibrate the model using data from Pakistan economy. The learning and determinacy analysis suggest monetary authority in developing economies to follow Taylor principle in large and to put some weight on exchange rate fluctuations even if there is relatively less inertia in the setting of policy interest rate.

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Article provided by Pakistan Institute of Development Economics in its journal The Pakistan Development Review.

Volume (Year): 51 (2012)
Issue (Month): 4 ()
Pages: 609-681

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Handle: RePEc:pid:journl:v:51:y:2012:i:4:p:609-681
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