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Monetary Policy and the Output Gap in DSGE Models for Small Open Economies: Insights from the Czech Republic

Author

Listed:
  • Tomas Sestorad
  • Jan Vlcek
  • Karel Musil

Abstract

This paper examines how alternative definitions of the output gap influence the dynamics and monetary policy prescriptions of New Keynesian DSGE models used in inflation-targeting regimes. Using the Czech economy as an example of a small open economy, we compare one exogenous and seven endogenous output-gap measures, including flexible equilibrium concepts, statistical filters, and structural approaches. The results show that endogenous identification is essential for ensuring internal consistency among business cycle fluctuations and other macroeconomic variables, while only structurally identified gaps fully exploit the advantages of the DSGE framework. Technology-augmented output emerges as the most operationally robust and conceptually coherent measure for real-side policy analysis. The findings further highlight that the policy implications of output-gap stabilization are determined by the chosen measure, which should align with the policymaker's preferences. Because these mechanisms are structural rather than country-specific, the conclusions extend to other small open economies with similar characteristics.

Suggested Citation

  • Tomas Sestorad & Jan Vlcek & Karel Musil, 2026. "Monetary Policy and the Output Gap in DSGE Models for Small Open Economies: Insights from the Czech Republic," Working Papers 2026/03, Czech National Bank, Research and Statistics Department.
    • Handle: RePEc:cnb:wpaper:2026/03
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    References listed on IDEAS

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    1. James Morley & Jeremy Piger, 2012. "The Asymmetric Business Cycle," The Review of Economics and Statistics, MIT Press, vol. 94(1), pages 208-221, February.
    2. Michal Andrle & Tibor Hledik & Ondra Kamenik & Jan Vlcek, 2009. "Implementing the New Structural Model of the Czech National Bank," Working Papers 2009/2, Czech National Bank, Research and Statistics Department.
    3. Paul Corrigan & Hélène Desgagnés & José Dorich & Vadym Lepetyuk & Wataru Miyamoto & Yang Zhang, 2021. "ToTEM III: The Bank of Canada’s Main DSGE Model for Projection and Policy Analysis," Technical Reports 119, Bank of Canada.
    4. Mise, Emi & Kim, Tae-Hwan & Newbold, Paul, 2005. "On suboptimality of the Hodrick-Prescott filter at time series endpoints," Journal of Macroeconomics, Elsevier, vol. 27(1), pages 53-67, March.
    5. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, September.
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    JEL classification:

    • D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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