Working Paper: CEPR ID: DP4531
Authors: Jesper Lind; Marianne Nessn; Ulf Sderstrm
Abstract: We develop a structural model of a small open economy with gradual exchange rate pass-through and endogenous inertia in inflation and output. We then estimate the model by matching the implied impulse responses with those obtained from a VAR model estimated on Swedish data. Although our model is highly stylized it captures very well the responses of output, domestic and imported inflation, the interest rate, and the real exchange rate. In order to account for the observed persistence in the real exchange rate and the large deviations from UIP, however, we need a large and volatile premium on foreign exchange.
Keywords: Calibration; Estimation; New Open-Economy Macroeconomics; Structural Open-Economy Model
JEL Codes: E52; F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| contractionary monetary policy shock (E49) | decline in output (E23) |
| contractionary monetary policy shock (E49) | decline in domestic inflation (E31) |
| contractionary monetary policy shock (E49) | decline in imported inflation (E31) |
| contractionary monetary policy shock (E49) | quick appreciation of the real exchange rate (F31) |
| real exchange rate shows gradual response due to large premium on foreign bond holdings (F31) | observed deviations from UIP (F31) |
| habit formation parameter and premium on foreign exchange (F31) | model's ability to replicate observed dynamics in the Swedish economy (C59) |