Alternative Monetary Regimes in a DSGE Model of a Small Open Economy with Two Sectors and Sticky Prices and Wages

Guillermo Escudé ()

Ensayos Económicos, 2007, vol. 1, issue 49, 65-138

Abstract: This paper develops a dynamic stochastic general equilibrium (DSGE) model for a small open economy (SOE) that can be calibrated to simulate the macro dynamics of a semi-industrialized developing country like Argentina. We consider a multilateral non-commodity trade environment, with the USA and Europe as trade partners, and assume that the Law of One Price does not hold for the goods that the USA and Europe trade between them. We show that this makes the USA´s multilateral real exchange rate (MRER) a key fundamental for the SOE´s MRER, in addition to its terms of trade. The SOE produces and consumes exportable and non tradable goods using labor (and in the case of exportables, imports). There is a representative, perfectly competitive firm producing exportables and operating under perfectly flexible export and import prices. Monopolistic competition with price (wage) stickiness prevails for non-tradable firms (households). These set prices (wages) subject to a price/wage adjustment cost function. There coexist both forward and backward looking firms. The latter use a "rule of thumb" to change prices that gradually corrects their price to that of optimizing firms. Alternative monetary or foreign exchange policy rules, including a fixed exchange rate, inflation targeting under a pure float and inflation targeting under a managed float, complete the dynamic systems. The non-stochastic steady state is analyzed in detail for the alternative models and the log-linearized systems are obtained.

Keywords: DSGE models; exchange rate policy; monetary policy; small open economy; sticky prices and wages (search for similar items in EconPapers)
JEL-codes: E52 F31 F41 (search for similar items in EconPapers)
Date: 2007
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Related works:
Working Paper: Alternative Monetary Regimes in a DSGE Model of a Small Open Economy with Two Sectors and Sticky Prices and Wages (2006)
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