The Effect of International Monetary Policy Expansions on Costa Rica

This paper studies if the international monetary policy has a major effect on the Costa Rican economy. The analysis is performed estimating a structural Bayesian vector autoregression (SBVAR) and a dynamic stochastic general equilibrium (DSGE) small open economy model estimated with Bayesian maximum likelihood methods using data from 2000 to 2014. The SBVAR estimation provides evidence that shocks to us interest rates, us inflation and us output in conjunction accounts for the following share of fluctuations: 43.2%, of nominal exchange rates; 52.2% of Costa Rican interest rates; 35.1% of Costa Rican inflation; 51.4% of Costa Rican output; 36.7% of exports; and 39.3% of imports. The DSGE model describes the mechanisms through which the local and foreign disturbances affect Costa Rica. An unexpected increase in the local interest rates means that the holding of local assets by the rest of the world increases; and it also incentives savings, which means postponed consumption. Households substitute depsits, local and foreign currency, with government debt. As expected the substitution of savings by government debt means there is no greater investment in the economy due to an increase in the risk premium. Meanwhile, an unexpected expansion in the us interest rate causes an outflow of resources from the economy, which along with the interest rate increase causes a depreciation of the currency and an increase in the local interest rate. Therefore consumption decreases and exports increase.