The Role of Monetary and Fiscal Policies in Ensuring Macroeconomic Stability in Romania

The purpose of this paper is to make an analysis of the dynamics of macroeconomic mechanisms of propagation of shocks in the Romanian economy based on a dynamic stochastic general equilibrium model (DSGE) that is based on optimizing behaviour of economic agents, using micro-foundations incorporating nominal rigidities in prices and wages. The model developed is Neo-Keynesian type model and is described based on the Christiano et al (2005) and Smets and Wouters (2003). It incorporates persistence in consumption, sticky prices and wages in Calvo sense, costs of adjustment of investment, variable capacity utilization and fixed costs in production. The model takes into account also the liquidity constraints consumers - rule of thumb, element introduced by Galí et al (2007). Another assumption of the model is the consideration of imports as an input in production, under the approach of McCallum and Nelson (2001). Changes over the standard dynamic stochastic equilibrium are related to inflation inertia generated by the learning process. An innovative element is the consideration of two monetary regimes considering adopting inflation targeting strategy in Romania in August 2005. Structural break is explicitly considered by considering two sub-samples and the estimation process of parameters is in two stages similar to the approach proposed by Jakab (2008).