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An Estimated Stochastic General Equilibrium Model with Partial Dollarization: A Bayesian Approach

  • Paul Castillo
  • Carlos Montoro
  • Vicente Tuesta

This paper develops and estimates a dynamic stochastic general equilibrium New Keynesian model of a small open economy with partial dollarization. We use Bayesian techniques and Peruvian data to evaluate two forms of dollarization: currency substitution (CS) and price dollarization (PD). Our empirical results are as follows. First, we find that the two forms of partial dollarization are important to explain the Peruvian data. Second, models with both forms of dollarization dominate models without dollarization. Third, a counter-factual exercise shows that by eliminating both forms of partial dollarization the response of both output and consumption to a monetary policy shock doubles, making the interest rate channel of monetary policy more effective. Forth, based on the variance decomposition of the preferred model (with CS and PD), we find that demand type shocks explain almost all the fluctuation in CPI inflation, being the monetary shock the most important (39 percent). Remarkably, foreign disturbances account for 34 percent of output fluctuations.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 381.

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Date of creation: Dec 2006
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Handle: RePEc:chb:bcchwp:381
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  1. Alejandro Justiniano & Bruce Preston, 2008. "Can Structural Small Open Economy Models Account for the Influence of Foreign Disturbances?," NBER Working Papers 14547, National Bureau of Economic Research, Inc.
  2. Olivier Blanchard & Jordi Galí, 2005. "Real wage rigidities and the new Keynesian model," Economics Working Papers 912, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2005.
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  4. Michael Woodford & Pierpaolo Benigno, 2004. "Inflation Stabilization and Welfare: The Case of a Distorted Steady State," 2004 Meeting Papers 481, Society for Economic Dynamics.
  5. Schmitt-Grohé, Stephanie & Uribe, Martín, 2002. "Closing Small Open Economy Models," CEPR Discussion Papers 3096, C.E.P.R. Discussion Papers.
  6. Paúl Castillo & Alberto Humala & Vicente Tuesta, 2012. "Regime shifts and inflation uncertainty in Peru," Journal of Applied Economics, Universidad del CEMA, vol. 0, pages 71-87, May.
  7. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
  8. Rabanal, Pau & Tuesta Reátegui, Vicente, 2006. "Euro-Dollar Real Exchange Rate Dynamics in an Estimated Two-Country Model: What is Important and What is Not," CEPR Discussion Papers 5957, C.E.P.R. Discussion Papers.
  9. De Paoli, Bianca, 2009. "Monetary policy and welfare in a small open economy," Journal of International Economics, Elsevier, vol. 77(1), pages 11-22, February.
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  11. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  12. Castillo, Paul & Montoro, Carlos & Tuesta, Vicente, 2009. "Un modelo de equilibrio general con dolarización para la economía peruana," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 17, pages 9-50.
  13. Humala, Alberto, 2007. "Expectativas de depreciación y diferencial de tasas de interés: ¿Hay regímenes cambiantes? El caso de Perú," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 14, pages 77-106.
  14. Jorge Selaive ; Vicente Tuesta, 2004. "Net Foreign Assets And Imperfect Financial Integration: An Empirical Approach," Econometric Society 2004 Latin American Meetings 90, Econometric Society.
  15. Kollmann, Robert, 2002. "Monetary Policy Rules in the Open Economy: Effects on Welfare and Business Cycles," CEPR Discussion Papers 3279, C.E.P.R. Discussion Papers.
  16. Rabanal, Pau & Rubio-Ramirez, Juan F., 2005. "Comparing New Keynesian models of the business cycle: A Bayesian approach," Journal of Monetary Economics, Elsevier, vol. 52(6), pages 1151-1166, September.
  17. Nicoletta Batini & Paul Levine & Joseph Pearlman, 2008. "Optimal Exchange Rate Stabilization in a Dollarized Economy with Inflation Targets," Working Papers 2008-004, Banco Central de Reserva del Perú.
  18. Camilo E Tovar, 2005. "The mechanics of devaluations and the output response in a DSGE model: how relevant is the balance sheet effect?," BIS Working Papers 192, Bank for International Settlements.
  19. Fernandez-Villaverde, Jesus & Francisco Rubio-Ramirez, Juan, 2004. "Comparing dynamic equilibrium models to data: a Bayesian approach," Journal of Econometrics, Elsevier, vol. 123(1), pages 153-187, November.
  20. Pau Rabanal & Vicente Tuesta, 2013. "Nontradable Goods and the Real Exchange Rate," Open Economies Review, Springer, vol. 24(3), pages 495-535, July.
  21. 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.
  22. Castillo, Paul & Montoro, Carlos & Tuesta, Vicente, 2007. "Hechos estilizados de la economía peruana," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 14, pages 33-75.
  23. Rabanal, Pau & Tuesta, Vicente, 2010. "Euro-dollar real exchange rate dynamics in an estimated two-country model: An assessment," Journal of Economic Dynamics and Control, Elsevier, vol. 34(4), pages 780-797, April.
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