Behavior of the Czech Economy: New Open Economy MacroeconomicsDSGE Model

Abstract

The paper introduces a New Keynesian Dynamic Stochastic General Equilibrium (NK DSGE) model. This model is derived from the New Open Economy Macroeconomics (NOEM). It is strictly based on microeconomic foundations and consists of sectors with representative agents. They are representative households and firms, a central monetary authority and a foreign economy. The foreign sector is exogenous in the model. The representative household maximizes its utility function with respect to its budget constraints. Consumption contains a habit formation factor and is divided between domestic and imported goods. The behavior is influenced by terms of trade, uncovered interest parity and purchasing power parity that includes some rigidities. The representative firm optimizes its behavior by setting prices of the production in a Calvo style. The result is relation called the New Keynesian Phillips Curve (NKPC). Monetary policy of the central bank is represented by a generalized Taylor rule. It changes the interest rate with respect to the output gap and a difference between inflation and the inflation target. The economic model is log linearized and transformed to a rational expectations model, which is solved. Parameters of the solved model are estimated by Bayesian method with Monte–Carlo simulation technique, which is using a priory set information. The estimated model together with the impulse responses gives a suitable approximation of behavior of the Czech economy. The model is also used for a forecast.

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