Should Hong Kong switch to Taylor rule?—Evidence from DSGE model

Zhiqi Zhao, David Meenagh and A. Patrick Minford

Applied Economics, 2022, vol. 54, issue 50, 5851-5872

Abstract: This paper studies the economy of Hong Kong through the lens of a small open economy DSGE model with a currency board exchange rate commitment. It assumes flexible prices and a banking system that provides credit to entrepreneurial household firms; the money supply is fully backed by reserves under the currency board. We estimate and evaluate the model by Indirect Inference over the sample period of 1994Q1-2018Q3; we find that it matches the data behaviour as represented by a VAR. We examined the economy’s volatility using bootstrapping of the model innovations, under both the estimated currency board model and a standard alternative regime with floating exchange rate and a Taylor rule; we found that Hong Kong welfare is higher in the currency board, which substantially reduces output volatility.

Date: 2022
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DOI: 10.1080/00036846.2022.2053655

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