The quantitative role of cost channel and UIP modification in an estimated small open economy DSGE model
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PhD Seminar (Econ)
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This paper examines the quantitative role of the cost channel and the uncovered interest rate parity (UIP) modification in an estimated small open economy DSGE model. For this purpose, a standard model (i.e., Justiniano and Preston 2010a) is augmented to incorporate (i) a cost channel of monetary policy and (ii) a UIP modification allowing that the risk premium is negatively correlated with the expected exchange rate depreciation. Alternatives of the augmented model are estimated using Bayesian methods with data for Australia and the G7 economy. The results show that introducing the cost channel and the UIP modification into the standard model improves its ability to fit the business cycle features of key macroeconomic variables and to account for the empirical evidence on the monetary transmission mechanism.
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