Scandinavian Working Papers in Economics

Discussion Papers,
Statistics Norway, Research Department

No 1026: Modeling exchange rate, inflation, and interest rate in a small open economy. A data-based approach to estimating a New Keynesian model with rational expectations

Roger Hammersland () and Dag Kolsrud ()
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Dag Kolsrud: Statistics Norway

Abstract: Building on a New Keynesian rational expectations framework, we develop a structural empirical model that jointly determines the real exchange rate, inflation, and the nominal interest rate in a small open economy. Employing a full-information system design and estimation approach that avoids imposing unduly restrictive a priori parameter constraints, we identify a forward-looking Phillips curve while addressing simultaneity bias. Our empirical findings reveal persistent exchange rate dynamics that diverge from New Keynesian rational expectations but align with prior evidence, suggesting the presence of multiple equilibria.

Keywords: New Keynesian Phillips curve; structural time series modeling; simultaneous model design and estimation

JEL-codes: C32; C51; E12; E31; F41

33 pages, August 2025

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