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

  • Niels Arne Dam

    (Institute of Economics, University of Copenhagen)

  • Jesper Gregers Linaa

    (Institute of Economics, University of Copenhagen)

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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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
Date of revision:
Handle: RePEc:kud:epruwp:05-02
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Web page: http://www.econ.ku.dk/epru/
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  16. Betts, Caroline & Devereux, Michael B., 1996. "The exchange rate in a model of pricing-to-market," European Economic Review, Elsevier, vol. 40(3-5), pages 1007-1021, April.
  17. Jordi Gali & Pau Rabanal, 2004. "Technology Shocks and Aggregate Fluctuations: How Well Does the RBS Model Fit Postwar U.S. Data?," NBER Working Papers 10636, National Bureau of Economic Research, Inc.
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