Scandinavian Working Papers in Economics

Working Paper Series,
Sveriges Riksbank (Central Bank of Sweden)

No 232: Monetary Policy Trade-Offs in an Estimated Open-Economy DSGE Model

Malin Adolfson (), Stefan Laseén (), Jesper Lindé () and Lars E.O. Svensson ()
Additional contact information
Malin Adolfson: Monetary Policy Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Stefan Laseén: Monetary Policy Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Jesper Lindé: Division of International Finance, Postal: Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue NW, Washington, DC 20551
Lars E.O. Svensson: Executive Board, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden

Abstract: This paper studies the transmission of shocks and the trade-offs between stabilizing CPI inflation and alternative measures of the output gap in Ramses, the Riksbank’s empirical dynamic stochastic general equilibrium (DSGE) model of a small open economy. The main results are, first, that the transmission of shocks depends substantially on the conduct of monetary policy, and second, that the trade-off between stabilizing CPI inflation and the output gap strongly depends on which concept of potential output in the output gap between output and potential output is used in the loss function. If potential output is defined as a smooth trend this trade-off is much more pronounced compared to the case when potential output is defined as the output level that would prevail if prices and wages were flexible.

Keywords: Optimal monetary policy; instrument rules; open-economy DSGE models; propagation of shocks; impulse responses; output gap; potential output

JEL-codes: E52; E58

40 pages, August 1, 2009

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