DP4531 Monetary Policy in an Estimated Open-Economy Model with Imperfect Pass-Through

Author(s): Jesper Lindé , Marianne Nessen , Ulf Söderström

Publication Date: August 2004

Keyword(s): structural open-economy model , new open-economy macroeconomics , estimation , calibration

JEL(s): E52 , F31 , F41

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP4531.asp

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.