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The Construction, Evaluation and Application of DSGE Model in Our Open Economy

Author: LiuHuaZhi
Tutor: ZuoMengHua
School: Dongbei University of Finance
Course: Quantitative Economics
Keywords: DSGE model Open Economy Bayes estimation Variancedecomposition financial accelerator
CLC: F224
Type: Master's thesis
Year: 2013
Downloads: 14
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Abstract


Since reform and opening, China’s economy has experienced huge fluctuations with rapid growth. The volatility of GDP growth is very obvious, and sometimes even differs by more than11percentage points. At the same time, consumption, investment and inflation volatility is also great. Facing with such huge economic fluctuations, there are natural questions that how economic fluctuations impact on China, what the causes of our economic fluctuations are, which Exogenous shocks plays a major role on macroeconomic volatility, and what kind of monetary policy rule can reduce macroeconomic volatility? The series of questions are the main subject of this study.This paper has created a micro-based open dynamic stochastic general equilibrium model (DSGE).The parameters of the model are estimated, with Chinese data, by using bayes inference method, and the nature of the model is assessed using impulse response and variance decomposition methods. Basing on the assessment of model, this paper makes a brief discussion of some applications in the financial markets, monetary policy and inflation of the output.The core model of this article is mainly based on Christiano,Trabandt and Walentin(2011). And it contains six subjects:households, banks, entrepreneurs, monopolistic intermediate goods production enterprises, competitive final goods and capital goods manufacturers. We add some of the characteristics of an open economy to expand the classical (closed) DSGE model. The model includes not only nominal and real frictions which have been confirmed in the closed economy, but also some literature research about the open economy macroeconomics. Model contains a large number of real and nominal frictions. They are sticky prices, consumption habit formation, adjustment costs, etc.; meanwhile, the model contains a large number of structural shocks. These shocks can help us observe the importance of China’s macroeconomic fluctuations which are from exogenous shocks sources. Finally, many financial factors are considered in this paper, mainly relating to financial accelerator effect caused between banks and entrepreneurs. These factors reflect the economic realities, and it will be better to describe the real economy by combining with them together.According the empirical analysis, we drawl the following conclusions:(1) Technology shocks, the impact of marginal efficiency of investment and monetary policy shocks are the real reasons which caused fluctuations of output China; consumption preference shock, the impact of imports and the impact of entrepreneurial risk and survival impact have a major impact on certain economic variables.(2) Price stickiness, capital adjustment cost and export prices sticky have the strongest interpretation of the data. The utilization of capital adjustment costs, and wage sticky friction are not of great importance.(3) China’s monetary policy is the main reason causing inflation volatility.(4) In the fluctuations of macroeconomics, Credit market is not only important sources of variation, but also a powerful wave transmission medium. Financial accelerator theory is useful in explaining the trajectory of China’s macroeconomic volatility characteristics.(5) Mixing monetary policy best suits China’s current economic and financial market development, and following is monetary policy whose intermediate targets are based on interest rate. And money supply rule is the worst.(6) The United States is an inflation exporting country, however, our country is importing one.Comparing to the existing research, innovation in this article is the listed below:(1) There are a lot of friction and exogenous structural shocks in this model.15kinds of friction and23structural shocks variable are considered in this paper, and the majorities are given detailed explanations and comparisons. These frictions and impacts will not only increase the capacity of model fitting the data, but also help us analyze what factors are the main cause of economic fluctuations.(2) The mixing rule based on New Keynesian model is optimal monetary policy rule for our country. Now most of the literatures about the choice of monetary policy rule are also limited in the money supply, and interest rate rule (or its extended form). In this paper, we compare the application of the money supply, interest rate rules and mixing rules in China.(3) Although there are some defects in making some comparison of the output effects in conduction direction between developed and emerging economies, it would be a good idea and direction to study output effects of inflation using DSGE model.

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