BOFIT Discussion Papers, Institute for Economies in Transition, Bank of Finland
Money Shocks in a Small Open Economy with Dollarization, Factor Price Rigidities, and Nontradeables
Abstract: The impact of an unanticipated monetary shock in a small
open economy with dollarization, factor price rigidities, and nontradeables
is re-examined in an optimizing intertemporal general equilibrium model.
The framework of an earlier study is extended to incorporate foreign real
money balances into the repre-sentative agent's utility function and to
account for the phenomenon of dollarization so characteristic of transition
economies. The major finding is that in the event of small monetary shocks,
the presence of dollarization does not alter the outcome that relates the
sign of response of consumption, current account balance, and other
macroeconomic variables to the difference between intertemporal and
intratemporal elasticities of substitutions of the total consumption index.
The solution also shows that the elasticity of intertemporal substitution
of money services and the share of traded goods in total consumption - a
proxy for openness of the economy - are the crucial parameters in
determining the response and the possibility of overshooting of the model
variables, with economic openness playing a stabilizing role for the
econ-omy in the event of monetary shocks.
Keywords: new open-economy macroeconomics; monetary shocks; dollarization; factor price rigidities; nontradeables; current account; (follow links to similar papers)
JEL-Codes: F31; F32; F41; F47; (follow links to similar papers)
68 pages, November 23, 2000
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