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Monetary Policy in Estimated Models of Small Open and Closed Economies

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  • Ali Dib

Abstract

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.

Suggested Citation

  • Ali Dib, 2003. "Monetary Policy in Estimated Models of Small Open and Closed Economies," Staff Working Papers 03-27, Bank of Canada.
  • Handle: RePEc:bca:bocawp:03-27
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Financial markets; Interest rates;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F2 - International Economics - - International Factor Movements and International Business
    • F3 - International Economics - - International Finance

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