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Foreign Output Shocks and Monetary Policy Regimes in Small Open Economies: A DSGE Evaluation of East Asia

Author

Listed:
  • Joseph D. ALBA

    (Division of Economics, Nanyang Technological University, Singapore 637332, Singapore)

  • Wai–Mun CHIA

    (Division of Economics, Nanyang Technological University, Singapore 637332, Singapore)

  • Donghyun PARK

    (Asian Development Bank6 ADB Avenue, Mandaluyong City,Metro Manila, Philippines 1550)

Abstract

East Asia’s small open economies were hit in varying degrees by the sharp drop in the output of major industrial countries during the global financial and economic crisis of 2008-2009. This highlights the role of monetary policy regimes in cushioning small open economies from adverse external output shocks. To assess the welfare impact of external shocks on key macroeconomic variables under different monetary policy regimes, we numerically solve and calculate the welfare loss function of a dynamic stochastic general equilibrium (DSGE) model. We find that CPI inflation targeting minimizes welfare losses for import-to-GDP ratios from 0.3 to 0.9. However, welfare under the pegged exchange rate regime is almost equivalent to CPI inflation targeting when the import-to-GDP ratio is one while the Taylor-type rule minimizes welfare when the import-to-GDP ratio is 0.1. We calibrate the model and derive welfare implications for eight East Asian small open economies.

Suggested Citation

  • Joseph D. ALBA & Wai–Mun CHIA & Donghyun PARK, 2011. "Foreign Output Shocks and Monetary Policy Regimes in Small Open Economies: A DSGE Evaluation of East Asia," Economic Growth Centre Working Paper Series 1105, Nanyang Technological University, School of Social Sciences, Economic Growth Centre.
  • Handle: RePEc:nan:wpaper:1105
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    References listed on IDEAS

    as
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    Keywords

    Trade channel; Import-to-GDP ratio; small open economies; welfare; exchange rate regimes; inflation targeting; Taylor rule; foreign output shock;

    JEL classification:

    • F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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