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Money Shocks in a Small Open Economy with Dollarization, Factor Price Rigidities, and Nontradeables

  • Sarajevs, Vadims

    ()

    (BOFIT)

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    The impact of an unanticipated monetary shock in a small open economy with dollarization, factor price rigidities, and nontradeables is re-examined in an optimizing intertemporal general equilibrium model. The framework of an earlier study is extended to incorporate foreign real money balances into the repre-sentative agent's utility function and to account for the phenomenon of dollarization so characteristic of transition economies. The major finding is that in the event of small monetary shocks, the presence of dollarization does not alter the outcome that relates the sign of response of consumption, current account balance, and other macroeconomic variables to the difference between intertemporal and intratemporal elasticities of substitutions of the total consumption index. The solution also shows that the elasticity of intertemporal substitution of money services and the share of traded goods in total consumption - a proxy for openness of the economy - are the crucial parameters in determining the response and the possibility of overshooting of the model variables, with economic openness playing a stabilizing role for the econ-omy in the event of monetary shocks.

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    File URL: http://www.suomenpankki.fi/bofit_en/tutkimus/tutkimusjulkaisut/dp/Documents/dp1200.pdf
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    Paper provided by Bank of Finland, Institute for Economies in Transition in its series BOFIT Discussion Papers with number 12/2000.

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    Length: 68 pages
    Date of creation: 23 Nov 2000
    Date of revision:
    Handle: RePEc:hhs:bofitp:2000_012
    Contact details of provider: Postal: Bank of Finland, BOFIT, P.O. Box 160, FI-00101 Helsinki, Finland
    Phone: + 358 10 831 2268
    Fax: + 358 10 831 2294
    Web page: http://www.suomenpankki.fi/bofit_en/
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    1. Obstfeld, M., 1998. "Risk and Exchange Rate," Papers 193, Princeton, Woodrow Wilson School - Public and International Affairs.
    2. Maurice Obstfeld & Kenneth Rogoff, 1994. "Exchange Rate Dynamics Redux," NBER Working Papers 4693, National Bureau of Economic Research, Inc.
    3. V.V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2002. "Can sticky price models generate volatile and persistent real exchange rates?," Staff Report 277, Federal Reserve Bank of Minneapolis.
    4. Kollman, R., 1996. "The Exchange Rate in a Dynamic-Optimizing Current Account Model with Nominal Rigidities: a Quantitative Investigation," Cahiers de recherche 9614, Universite de Montreal, Departement de sciences economiques.
    5. Lane, P, 1999. "The New Open Economy Macroeconomics: A Survey," Trinity Economics Papers 993, Trinity College Dublin, Department of Economics.
    6. Miguel A. Savastano, 1996. "Dollarization in Latin America; Recent Evidence and Some Policy Issues," IMF Working Papers 96/4, International Monetary Fund.
    7. Robert Feenstra & Paul Bergin, 2003. "Pricing To Market, Staggered Contracts, And Real Exchange Rate Persistence," Working Papers 991, University of California, Davis, Department of Economics.
    8. John B. Taylor, 1998. "Staggered Price and Wage Setting in Macroeconomics," NBER Working Papers 6754, National Bureau of Economic Research, Inc.
    9. Hau, Harald, 2000. "Exchange rate determination: The role of factor price rigidities and nontradeables," Journal of International Economics, Elsevier, vol. 50(2), pages 421-447, April.
    10. Guillermo Calvo & Carlos A. Végh Gramont, 1992. "Currency Substitution in Developing Countries; An Introduction," IMF Working Papers 92/40, International Monetary Fund.
    11. Sarajevs, Vadims, 2000. "Econometric Analysis of Currency Substitution: A Case of Latvia," BOFIT Discussion Papers 4/2000, Bank of Finland, Institute for Economies in Transition.
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