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A macroeconomic model and stability analysis by parameters.

Article Excerpt
Abstract

This article focuses on the New Keynesian multiple-equations small-open-economy macroeconomic model to illustrate deeper relations among model parameters. These relations are more important than the basic values of the parameters because it shows how the system behaves when some changes in the economy occur. The first stage of the analysis introduces a theoretical model. The second stage of the analysis estimates the states and parameters of the model on the quarterly data of the Czech economy. The third stage of the analysis focuses on the transfer function of this model and makes a deeper behavior analysis. In the final stage, the article demonstrates the stability of the model, shown through the impulse functions of the model. This shows response of the macroeconomic model to unanticipated shocks. (JEL C13, C32, E12, E17)

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Introduction

This article focuses on the New Keynesian multiple-equations small-open-economy macroeconomic model to illustrate deeper relations among model parameters. It is directed to analyze certain properties of monetary policy and to find stable target variables and suitable reactions in the form of the optimal monetary rule for governing monetary policy in a small open economy in the regime of inflation targeting. The purpose of this paper is to identify this macroeconomic model. The impulse response of this model can be seen in Figure 1.

The oscillation behavior of the model is apparent. This paper shows the crucial influence of the parameters on the oscillations of the impulse response. Monetary policy can control its behavior by setting the appropriate variable in the monetary policy rule (this paper uses the Taylor policy rule). It is also possible to investigate the properties of the monetary policy rule only in relation to key economic characteristics, such as transmission mechanisms and the length of the lags in reaction to shocks. In order to analyze properties, the paper develops a formal framework describing the behavior of the economy. Its structural model was constructed for the open economy to serve the purpose of the previously mentioned analysis. The following sections describe the structure of the model and present its estimated states and parameters. The paper uses the Czech economy as a case study for this model.

Stability of the economic systems presented in the previously mentioned framework is examined through its transfer function. This is shown in the following sections together with the analysis of zeros and poles of the systems. This analysis is utilizing procedures from the theory of the dynamic systems.

[FIGURE 1 OMITTED]

The following sections present the influence of poles on responses to economic shocks and include linear rational expectations into the baseline framework as the forward-looking variables. It also examines impulse response of the baseline framework to the example of an aggregate supply shock in this subsection.

Baseline framework

The model specified for the Czech Republic has the form of a standard New Keynesian multiple-equations small-open-economy macroeconomic model. It is a dynamic model without money. This type of model has become widely used for a theoretical analysis of monetary policy [Clarida et al., 1998, 1999; David, 2003; Rotemberg and Woodford, 1998]:

y_gap[.sub.t] = -1/[sigma][[i.sub.t]/4 - [E.sub.t]([[pi].sub.t+1.sup.n]) - r_eq[.sub.t]/4] + k[alpha]y_gap[.sub.t-1] + k(1 - [alpha])[E.sub.t](y - gap[.sub.t+1]) + [[eta].sub.1][DELTA]lz - gap[.sub.t] + [[eta].sub.2]y_gap[.sub.t.sup.f] + [[omega].sub.t.sup.y-gap]. (1)

[[pi].sub.t.sup.n] = [[lambda].sub.o]y - gap[.sub.t] + [[lambda].sub.1]y_gap[.sub.t-1] + [[psi].sub.1][E.sub.t]([[pi].sub.t+1.sup.n]) + [[psi].sub.2][[pi].sub.t.sup.M] + (1 - [[psi].sub.1] - [[psi].sub.2])[[pi].sub.t-1.sup.n] +...

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