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Forecasting with a DSGE Model of a Small Open Economy within the Monetary Union
Author(s) -
Marcellino Massimiliano,
Rychalovska Yuliya
Publication year - 2014
Publication title -
journal of forecasting
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.543
H-Index - 59
eISSN - 1099-131X
pISSN - 0277-6693
DOI - 10.1002/for.2306
Subject(s) - dynamic stochastic general equilibrium , economics , small open economy , vector autoregression , monetary policy , new keynesian economics , econometrics , open economy , unemployment , macroeconomics , interest rate , consumption (sociology) , wage , keynesian economics , monetary economics , exchange rate , market economy , social science , sociology
ABSTRACT In this paper we lay out a two‐region dynamic stochastic general equilibrium (DSGE) model of an open economy within the European Monetary Union. The model, which is built in the New Keynesian tradition, contains real and nominal rigidities such as habit formation in consumption, price and wage stickiness as well as rich stochastic structure. The framework also incorporates the theory of unemployment, small open economy aspects and a nominal interest rate that is set exogenously by the area‐wide monetary authority. As an illustration, the model is estimated on Luxembourgish data. We evaluate the properties of the estimated model and assess its forecasting performance relative to reduced‐form model such as vector autoregression (VAR). In addition, we study the empirical validity of the DSGE model restrictions by applying a DSGE‐VAR approach. Copyright © 2014 John Wiley & Sons, Ltd.