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What Drives Business Cycles in a Small Open Economy with a Fixed Exchange Rate?

Author Info

Listed author(s):
  • Niels Arne Dam

    (Institute of Economics, University of Copenhagen)

  • Jesper Gregers Linaa

    (Institute of Economics, University of Copenhagen)

Abstract

We decompose the Danish business cycle into ten structural shocks using an open-economy DSGE model with infrequent determination of prices and wages which we estimate with Bayesian techniques. Consistent with the Danish monetary policy regime, we formulate an imperfect peg on the foreign exchange rate and analyse the resulting monetary transmission mechanism. We find that the Danish business cycle is dominated by stochastic movements in the labour supply in the long term, while demand shocks play a major role in the short term. Remarkably, the role of technology is negligible, and foreign factors only contribute little to the Danish business cycle, especially in the long term. With respect to the estimation, we generally find believable estimates although the degree of price stickiness is remarkably high.

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File URL: http://www.econ.ku.dk/epru/files/wp/wp-05-02.pdf
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Paper provided by Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics in its series EPRU Working Paper Series with number 05-02.

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Length: 30 pages
Date of creation: Mar 2005
Handle: RePEc:kud:epruwp:05-02
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Web page: http://www.econ.ku.dk/epru/
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Keywords: open economy; peg; business cycles; Bayesian estimation;

Find related papers by JEL classification:

  • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
  • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
  • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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  8. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
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  10. Jordi Gali Garreta & Pau Rabanal, 2004. "Technology Shocks and Aggregate Fluctuations; How Well Does the RBC Model Fit Postwar U.S. Data?," IMF Working Papers 04/234, International Monetary Fund.
  11. David Altig & Lawrence Christiano & Martin Eichenbaum & Jesper Linde, 2011. "Firm-Specific Capital, Nominal Rigidities and the Business Cycle," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 14(2), pages 225-247, April.
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  17. Kollmann, Robert, 2001. "Explaining international comovements of output and asset returns: The role of money and nominal rigidities," Journal of Economic Dynamics and Control, Elsevier, vol. 25(10), pages 1547-1583, October.
  18. Kollmann, Robert, 2002. "Monetary policy rules in the open economy: effects on welfare and business cycles," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 989-1015, July.
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  20. Sims, Christopher A, 2002. "Solving Linear Rational Expectations Models," Computational Economics, Springer;Society for Computational Economics, vol. 20(1-2), pages 1-20, October.
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Cited by:

  1. Sigitas Karpavicius, 2009. "The Effects of Fiscal Instruments on the Economy of Lithuania," Bank of Lithuania Working Paper Series 4, Bank of Lithuania.
  2. Niels Arne Dam & Jesper Gregers Linaa, 2005. "Assessing the Welfare Cost of a Fixed Exchange-Rate Policy," EPRU Working Paper Series 05-04, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  3. Søren Ravn & Morten Spange, 2014. "The Effects of Fiscal Policy in a Small Open Economy with a Fixed Exchange Rate," Open Economies Review, Springer, vol. 25(3), pages 451-476, July.

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