Monetary policy, informality and business cycle fluctuations in a developing economy vulnerable to external shocks

Transcription

1 MPRA Munh Personal RePE Arhve Moneary poly nformaly and busness yle fluuaons n a developng eonomy vulnerable o exernal shoks Adnan ader and Musleh-ud Dn and Ejaz Ghan Moneary Poly Deparmen Sae Bank of Paksan. Paksan Insue of Developmen Eonoms (PIDE) Paksan 4. Oober 22 Onlne a hps://mpra.ub.un-muenhen.de/42484/ MPRA Paper No posed 6. November 22 8:47 TC

2 Moneary Poly Informaly and Busness Cyle Fluuaons n a Developng Eonomy Vulnerable o Exernal Shoks ADNAN AIDER * MSE-D DIN EJAZ GANI Moneary Poly Deparmen Sae Bank of Paksan Paksan Insue of Developmen Eonoms Islamabad Paksan Oober 4 22 ABSTRACT Ths paper develops an open eonomy dynam sohas general equlbrum (DSGE) model based on New- Keynesan mro-foundaons. Alongsde sandard feaures of emergng eonomes suh as a ombnaon of produer and loal urreny prng for exporers foregn apal nflow n erms of foregn dre nvesmen and ol mpors hs model also norporaes nformal labor and produon seors. Ths usomzaon nensfes he exposure of a developng eonomy o nernal and exernal shoks n a manner onssen wh he sylzed fas of Busness Cyle Fluuaons. We hen fous on opmal moneary poly analyss by evaluang alernave neres rae rules and albrae he model usng daa from Paksan eonomy. The learnng and deermnay analyss sugges moneary auhory n developng eonomes o follow Taylor prnple n large and o pu some wegh on exhange rae fluuaons even f here s relavely less nera n he seng of poly neres rae. Key Words: Moneary Poly Informal Eonomy Busness Cyles DSGE JE Classfaons: E26 E32 E35 E37.. INTRODCTION Modellng he soures of Busness Cyle Fluuaons (BCF) n an open eonomy Dynam Sohas General Equlbrum (DSGE) framework s a fasnang area of researh. The man advanage of hs framework over radonal modelng approah s due o an addonal feaure of mro-foundaons n erms of welfare opmzaon. Ths feaure allows sruural nerpreaon of deep parameers n a way ha s less skepal o uas rque (uas 976). In DSGE modelng onex he soures of BCF are normally vewed as exogenous shoks whh have poenal power o propagae he key endogenous varables whn he sysem. Ths requres a areful denfaon as he ransmsson of hese shoks may emanae from nernal sde suh as polal nsably; weak nsuonal qualy n erms of low governane or from exernal sde suh as naural dsaser (lke earh quaks and floods); nernaonal ol and ommody pres; sudden sops n foregn apal nflows; hanges n erm of rade and exhange rae or any ombnaon of shoks from boh sdes. Also he naure and magnude of hese shoks may vary dependng upon her varanes and perssene levels. * Adnan ader <adnan.hader@sbp.org.pk> s Researh Analys n Moneary Poly Deparmen a Sae Bank of Paksan Karah Paksan. Musleh-ud Dn <muslehuddn@pde.org.pk> and Ejaz Ghan <ejaz@pde.org.pk> are Jon Dreor and Chef of Researh respevely a Paksan Insue of Developmen Eonoms Islamabad Paksan. The auhors are graeful o amza Al Malk Safdar llah Khan Sajawal Khan Farooq Pasha and Mansoor Saleem for provdng her useful ommens and suggesons on he earler draf of hs paper. They are also hankful o Asad Jan and Shahzad Ahmad for provdng exellen edoral asssane. The vews expressed n hs paper are hose of he auhors and no neessarly of he Sae Bank of Paksan or Paksan Insue of Developmen Eonoms. The oher usual dslamer also apples. Aordng o Frsh s vew on busness yle a BCF s he ylal hange n he maroeonom ndaor around s rend. See for nsane Frsh (933) uas (977) Blanhard and Wason (986) and Bormoov (29). --

3 Afer he semnal work of Kydland and Preso (982) a subsanal body of researh has been ondued o denfy key possble soures of BCF and o undersand propagaon mehansms of hese exogenous shoks. Bu he earler aemps have manly foused on hgh-nome ounres lke S and Euro-Zone. Bu for developng ourers lke Paksan small amoun of effors have been made o undersand he dynams of BCF. 2 Daa lmaons have ofen onsdered as roo ause (Ban e al. 2a and 2b). As here s an nheren lak of mroeonom-based surveys and even hgh-frequeny daa on major maroeonom varables s mosly unavalable (Ahmad e al. 22). Furher he sruure of eonomy n developng ounres s parally dfferen as ompared wh he advaned ounres due o he exsene of large nformal seor. Sruures of goods labour and red markes are que dfferen n formal and nformal seor of eonomy due o varaons n endowmens and onsrans of agens. When relave sze of nformal seor s small (as n developed eonomes) hen gnorng nformal seor may be plausble on he ground ha has very lmed mpa on aggregaes. owever f nformal seor represens a non-rval (Shneder e al. 2) fraon of an eonomy as observed n many developng eonomes hen negleng nformal seor n some mrofounded DSGE model may no be jusfed. Table : Sylzed Fas abou Busness Cyles: A omparson of Developed and Developng Counres Busness Cyle Sass Counres (Y) (C)/ (Y) (I)/(Y) (NX)/(Y) (YY-) (CY) (IY) (NXY) Paksan* Developng Eonomes** Argenna Brazl Euador Israel Korea Malaysa Mexo Peru Phlppnes Slovak Republ Souh Afra Thaland Turkey Developed Eonomes** *Auhor's personal esmaes based on Paksan daa [95-2]. **Based on Aguar and Gopnah (27). owever reen sudes 3 ome forward wh some sylzed-fas of BCF n developng ounres. Table- provdes a summary of busness yle sass of varous maroeonom ndaors n boh absolue and relave erms. Ths able shows ha: aggregae nome s more volale n developng ounres as ompared wh developed ounres prvae onsumpon and nvesmen relave o aggregae nome are subsanally more volale ne expors s ounerylal wh aggregae nome and real neres raes. owever f we fous on Paksan eonomy exlusvely and ompare s busness yle sass wh oher developng ounres hen we an observe ha aggregae nome s more volale. Ths volaly s manly rggered from ne expors whh s a man omponen of aggregae demand. The remanng resuls are n lne wh busness yle sass as we observed n res of seleed developng ounres. Based upon hese fas hs sudy arres wo dmensonal movaon agenda. Frs n developng eonomes lke Paksan wh omplex eonom sruures one of he endurng researh 2 ader and Khan (28) Ahmad e al. (22) and Choudhr and Malk (22) are few noable examples. 3 See for nsane Ban e al. (2a 2b) Agenor and Monel (2) Aguar and Gopnah (27) Neumeyer and Perr (25) Agenor e al. (2). -2-

4 quesons s o onsru and albrae a vald mro-founded DSGE model feaured wh nomnal and real rgdes. Ths ssue s really hallengeable as suh eonom model whh omprehensvely explores he ransmsson mehansm of eonom behavors n he developng eonomes s sarely avalable due o unavalably of hgh frequeny daa and beause of a major share of he undoumened eonomy n he observed eonom daa. Furhermore due o naure of small open emergng eonomy BCF are manly prone o exernal shoks lke nernaonal ol and ommody pre shoks and sudden sops n apal nflows manly n erms of foregn dre nvesmen. Ths requres an nensve usomzaon of readly avalable DSGE models whh are apable o answer hese dynams espeally n he onex of developng ounres. Therefore hs sudy omes forward o mee hese hallenges by onsrung a small open eonomy DSGE model feaure wh nformal seors vs-à-vs varous exernal shoks. More spefally we develop a wo-blo DSGE model of a small open eonomy (SOE) nerang wh he res of he world. Alongsde sandard feaures of SOE suh as a ombnaon of produer and loal urreny prng for exporers foregn apal nflow n erms of foregn dre nvesmen and ol mpors [see for nsane Ban e al. (2a) Kolasa (28) Medna and Soo (27) u (26) Gal and Monaell (25) and ubk and Shorfhede (25)] our model also norporaes nformal seors [whle onsderng nformal goods produon and nformal labor supply desons by households see for example Ahmad e al. (22) and Ban e al. (2a)]. Ths nensfes he exposure of a SOE o nernal and exernal shoks n a manner onssen wh he sylzed fas lsed above. We hen fous on opmal moneary poly analyss by albrang he model usng daa from Paksan eonomy. The res of he essay s organzed as follows: seon wo provdes a omprehensve leraure revew seon hree dsusses some sylzed-fas of Paksan eonomy seon four layou he sruure of he model; seon fve dsusses empral albraon resuls; and fnally las seon onludes. 2. ITERATRE REVIEW DSGE modelng based on New-Keynesan (NK) framework 4 has emerged as a powerful ool o analyze varous maroeonom poles whh are essenally forward-lookng n naure. The erm DSGE was orgnally asrbed by Kydland and Preso (982) n her semnal work on Real Busness Cyle (RBC) model. Ths modelng approah s based on lassal-axoms of flexble pres and money neuraly. The nal onrbuon on RBC augmens he neo-lassal Ramsey Cass Koopmans growh model by nrodung sohas ehnology shoks. 5 Kydland and Preso (982) Alug (989) and many of her followers emprally show ha suh a modelng approah s apable of reprodung a number of sylzed fas of he busness yle of S eonomy. Anoher reason of populary of hese models n he early 99 s ha hese are feaured wh sold mro-foundaons of eonom agens n erms of welfare opmzaons subje o varous nenve onsrans [for example budge onsrans ehnologal onsrans]. 6 The agens-opmzaon proess mplly onsders Raonal Expeaon ypohess (RE). These nnovaons gve many advanages over he use of radonal Tnbergen (953) ype redue-form maroeonom models. Among hem he mos mporan advanage s ha he sruural nerpreaons of deep parameers of RBC ype models are less vulnerable o uas rque (uas 976). The radonal maro-eonomer models onaned equaons lnkng varables of neres of explanaory faors suh as eonom poly varables. One of he uses of hese models s herefore o examne how a hange n eonom poly affes hese varables of neres oher hngs beng equal. owever n he RBC approah sne he equlbrum ondons for aggregae varables an be ompued from he opmal ndvdual behavor of onsumers and frms. Furher he RE enables hs opmal 4In maroeonom leraure he erms new-keynesan or new-neolassal synhess are beng used synonymously; see Clarda Gal and Gerler (999) Gal and Gerler (27) Goodfrend (27) Goodfrend and Kng (997) Mankw (26) and Romer (993 2). 5 Ths approah s nspred wh Frsh s vew of he busness yles (Frsh 933). 6Spefally RBC ype models deals nfnely-lved represenave agens whose objeve s o maxmze s uly by hoosng an opmal pah for onsumpon real money balanes and lesure as well as a represenave frm whose objeve s o maxmze profs. -3-

5 behavor of prvae agens o use avalable nformaon raonally so n hs way hey should respond o eonom poly announemens by adjusng her supposedly aons. Therefore resuls oban from varous poly smulaons n hose redue-form models whh do no use RE are hghly skepal o uas rque. Bu as RBC ype models are based on opmzng agens wh RE so sruural parameers are nvaran o uas-skepsm. Despe hese over-rdng advanages he RBC models had rzed n erms of he usefulness for moneary or fsal poly smulaons. Ths s beause of he ral man assumpon of lassal dhoomy. Ths assumpon assume ha fluuaons of real quanes are aused by real shok only; ha s only sohas ehnology or governmen spendng shoks play her role. On he one hand many researhers fel ha he non-exsene mpa of moneary poly on busness yles s lkely downplayed he role of marke neffenes. On he oher hand he way n whh he empral f of hese models was measured ame under srong rsm. 7 See for nsane Summers (986) Cooley (995) Rebelo (25) and Romer (2). To address nheren weaknesses n RBC models laer researh however nluded Keynesan shor-run maroeonom feaures (usually alled nomnal rgdes or gradual boh of pre and wage adjusmen) suh as Calvo (983) ype saggered prng behavor and Taylor (98 998) ype wage onras. Ths provdes plausble shor-run dynam of maroeonom fluuaons wh fully arulaed desrpon of he moneary-um-fsal poly ransmsson mehansms [see for nsane Chrsano e al. (25) and Smes and Wouers (23 25)]. Suh new modelng framework labeled nerhangeably as New-Neolassal Synhess (NNS) or New-Keynesan (NK) modelng paradgm. 8 Ineresngly he nluson of NK deas no an oherwse RBC model proved o be exremely suessful n erms of reepon by he eonom professon as well as n erms of explanaory power of he empral evdene. In parular he nroduon of nomnal rgdes ogeher wh marke mperfeons suffen o break he neuraly of money ypal of RBC models and hene opened a new avenue for moneary poly analyss. Due o hese reasons he las deade shows a sharp neres n aadems nernaonal poly nsuons and enral banks n developng small-o-medum even largesale NK-DSGE models. 9 The earler aemps are based on he onsruon of losed eonomy NK-DSGE models [see Chrsano e al. (25) Smes and Wouers (23 27) and he referenes whn] wh hree man redue-form equaons: he New Keynesan Invesmen-Savng (NKIS) equaon he ybrd New- Keyenesan Phllps Curve (NKPC) and he moneary poly rule [lke Taylor ( ) or MCullam (988)]. Bu he laer emphass hanged from NK Closed eonomy frameworks o NK Open eonomy Maroeonoms (NOEM). Ths approah s based on he semnal work of Obsfeld and Rogoff (995) wh open eonomy foundaons as suggesed n Mundell-Flemng framework [See for example Adolfson e al. (27a 27b 28) Db e al. (28) Jusnano and Preson (24 25) u (26) Gal and Monaell (25) and ubk and Shorfhede (25)]. The salen feaures of NOEM models are: opmzaon-based dynam general-equlbrum modelng sky pres and/or wages n a leas some seors of he eonomy norporang of sohas shoks and evaluaon of moneary poles based on household welfare [Gal and Monaell (25) Monaell (25) and ubk and Shorfhede (2325)] he perssene of real and nomnal exhange raes [Char e al (22 27)] exhange rae pass-hrough [Devereux and Engel (22) Monaell (25) and Adolfson e al. (28)] and nernaonal ol pre shoks [An and Kang (29) and Medna and Soo ( )]. More spefally he model developed by ubk and Shorfhede 7 The falure of hese models o replae some of he empral regulares suh as lqudy effes o-movemen of produvy and employmen or he o-movemen of real wages and oupu (Kremer e al. 26). 8Romer (993) and Goodfrend and Kng (997) are n he vew ha suh ombned modelng framework s he resul of a synhess of real busness yle (RBC) heory and New Keynesan heory. 9 Some well-known NK-DSGE models developed by mos of he enral banks and nernaonal poly nsuons as noed by Tovar (28) are: (a) Bank of Canada (ToEM) (b) Bank of England (BEQM) () Cenral bank of Brazl (SAMBA) (d) Cenral bank of Chle (MAS) (e) Cenral bank of Peru (MEGA-D) (f) European Cenral bank (NAWM) (g) Norges Bank (NEMO) (h) Sverges Rksbank (RAMSES) () S Federal Reserve (SIGMA) and (j) IMF (GEM and GIMF). -4-

6 (25) s a smplfed and sraghforward verson of Kollmann (2) and Galí and Monaell (25). ke s losed-eonomy ounerpar he model onsss of an (open eonomy) forward lookng IS urve and a NKPC ype relaonshp whh deermne oupu and nflaon by allowng for monopols ompeon and saggered re-opmzaon n he mpor marke as n Calvo-ype saggered pre seng respevely. The erm of rade s nrodued va he defnon of he onsumer pre ndex (CPI) and under he assumpon of purhasng-power pary (PPP). The exhange rae s derved from he unovered neres rae pary ondon. Moneary poly s desrbed by a nomnal neres rae rule and model s smulaed by usng Bayesan esmaon approah. Alhough modern open eonomy NK-DSGE models f he daa well emprally and able o explan many poly relaed quesons ogeher wh he propagaon of exogenous shoks. Bu hese models are essenally onsrued for advaned (S or European) ounres. Bu n onex of developng ounres; however he objeve (for example empral f) anno be aheved by smply replang NK-DSGE models buld for developed ounres As he sruure of eonomy n developng ounres s parally dfferen as ompared wh he advaned ounres due o he exsene of large nformal seor. Sruures of goods labour and red markes are que dfferen n formal and nformal seor of eonomy due o varaons n endowmens and onsrans of agens. When relave sze of nformal seor s small (as n developed eonomes) hen gnorng nformal seor may be plausble on he ground ha has very lmed mpa on aggregaes. owever f nformal seor represens a nonrval (Shneder 2) fraon of an eonomy as observed n many developng eonomes hen negleng nformal seor n some mro-founded NK-DSGE model may no be jusfed. Keepng n vew of poenal mplaons of nformal seors espeally n he onex of emergng marke eonomes new modelng researh res o exend NK-DSGE models wh he dynams of nformaly. Ban e. al. (2b) provde a omprehensve survey of general equlbrum models wh nformal seors. Ths survey overs ssues rangng from defnonal problems aahed wh underground eonomy o DSGE models norporang nformaly. Wh a fous on nformal labour and red markes hs survey emphaszes he developmen of DSGE models for beer undersandng of oss benefs and poly mplaons assoaed wh nformal seor. In a subsequen researh Ban e. al. (2a) analyze oss and benefs of nformaly usng a dynam NK-DSGE model. In her model formal seor s axed apal nensve hghly produve and has frons n labour marke. Informal seor on he oher hand s unaxed labour nensve less produve and has fronless labour marke. Indene of ax burdon only on formal seor and fluuaons semmng from ax fnanng are major oss whereas wage flexbly has been lsed as benef of nformaly. Poly expermens of ax smoohng lead hs sudy o onlude ha oss of nformaly are greaer han s benefs. Ahmad e. al. (22) develop a losed eonomy DSGE model for Paksan eonomy where hey norporae nformaly n labour and produ markes. Ths sudy fnds ha ransmssons of produvy fsal and moneary poly shoks o nformal seor are weak. In hs way nformal seor damps he mpa of shoks o eonomy. Gabrel e. al. (2) onsrus n a smlar framework a losed eonomy NK-DSGE model for Indan eonomy and esmaes usng Bayesan mehods. Ths model has more feaures of lqudy onsraned onsumers fnanal aeleraor and nformal seor n produ and labour markes. Ths sudy sep-by-sep adds feaures of fnanal frons and nformal seor o a anonal dynam New Keynesan model and onludes ha addon of fnanal frons and nformal seor mproves model f n ase of Indan eonomy. Aruoba (2) doumens he assoaon of nsuons wh nformaly nflaon and axaon usng daa se of 8 ounres. Ths sudy fnds beer nsuons are assoaed wh low level of nformaly hgh nome axaon and low nflaon axaon. On he oher hand poor nsuons are assoaed wh hgh level nformaly low nome axaon and hgh nflaon axaon. Afer dsussng hese sylzed fas from daa he sudy presens a general equlbrum model n whh households opmally dedes abou quanum of nformal avy for exogenous ondon of nsuons. Smlarly governmens opmally dede abou her mx of nome ax and nflaon ax o fnane her expendures. The sudy lams hs model does a reasonable job n explanaon of ross dfferenes n nflaon nformal avy and axaon. -5-

7 Ngalawa and Veg (2) develop a DSGE model o sudy ner-dependene of formal and nformal fnanal seors and mpa of nformal fnanal seor on overall eonom avy and moneary poly n onex of quas emergng marke eonomes. The model smulaons reveal omplemenary beween he wo fnanal seors. Inrease n formal red auses a parallel nrease n nformal seor red. In response o moneary poly shok neres raes n he wo seors move n oppose dreons; makng he ondu of moneary poly hard n presene of large nformal fnanal seors. Zenou (27) develops wo-seor general equlbrum model o sudy labour mobly beween formal and nformal labour markes under dfferen labour poles. In he model desgn formal labor marke has searh and mahng frons and nformal labour marke exhbs perfe ompeon. The sudy onludes ha reduon n unemploymen benefs or formal frms enry os auses nrease n formal employmen and an nverse mpa on nformal seor employmen. Alhough no drely regulaed ye nformal seor labour marke s no ndependen of poles applable on formal labour marke due o nerdependene of boh markes. Anunes and Cavalan (27) sudy he mpa of regulaon oss and fnanal onra enforemen on sze of nformal eonomy and per apa GDP usng a small open eonomy general equlbrum model. The sudy onludes ha regulaon oss are more mporan n aounng for nformaly. owever n a ounry where enforemen s very poor e.g. Peru regulaon oss and enforemen of fnanal onras are equally mporan for explanaon of nformal seor. Regulaon oss and enforemen are no muh helpful for explanng nome dfferene aross ounres. Koreshkova (26) sudes he onsequenes of ax-evadng nformal seor for budge fnanng ha ulmaely affes nflaon. sng ross ounry daa he sudy shows ha sze of nformal seor fnanng of governmen expendure hrough segnorage and nflaon are posvely assoaed. Afer esablshmen of sylzed fas he sudy uses a wo-seor general equlbrum model o analyze mplaons of nformal seor for nflaon. Cross ounry smulaons of he model show ha n presene of large nformal seors where axes are no pad fnanng of governmen expendures hrough nflaon ax s onssen wh soluon of Ramsay problem. Conesa e. al. (22) explans he negave relaonshp beween parpaon rae and GDP fluuaon observed n ross ounry daa hrough exsene of nformal seor. sng a dynam general equlbrum model norporang nformal seor n labour and produ markes he sudy shows ha agens swh beween formal and nformal seors durng produvy shoks. Ths ranson enhanes he mpa of shoks on regsered oupu and ulmnaes no amplfaon of fluuaons. 3. PAKISTAN ECONOMY: SOME STYIZED-FACTS The hsory of Paksan eonomy has showng a hgh degree of polal unerany. Afer every auora regme eonomy rebounded n he roublng poson by posng sagnan eonom growh and unsable pres. In mos of polally-eleed regmes Paksan has experened wh hgh nflaon raes large budge defs and low growh n prvae seor red. These regmes also wnessed wobbly exernal seor along wh large rade def and delnng rend n apal nflows boh n he form of foregn dre nvesmens and porfolo nvesmens whh ndaes low level of onfdene of foregn nvesors n he domes eonomy. The mos reen epsode of alernave regmes n Paksan s an obvous llusraon of hs belef. Afer havng seven suessful years (auora regme of General Pervaz Musharaf espeally from FY o FY8) of hgh growh balaned fsal and exernal poson and hgh nvesmens he ounry suffered hsor nflaon falerng eonom growh nrease n wn def reord low nvesmen and rapd aumulaon of publ deb ha nreases ner-emporal deb burden. Table 2 porrays he performane of seleed maroeonom varables durng urren epsode. Spefally he onsumer pre nflaon nreased o around 9 peren durng FY9 and remaned perssen aferwards. The eonomy grew around 3 peren durng he las four years as ompared wh over 7 peren average growh observed durng auora regme. The neres rae nreased n andem -6-

8 o he overall nflaon ha has negave mpa on nvesmen. The mpa of low nvesmen s also refleed from he onraon of large sale manufaurng durng he las few years. On exernal sde he rade def wdened o hsoral hgh level of over 3 peren of GDP n FY8 and remaned unabaed aferwards. The urren aoun def nreased o unsusanable level of over 8 peren n FY8. All hese developmens are he manfesaon of polal unerany deerorang law and order suaon prolong power ouages and severe energy shorages. As a onsequene foregn nvesmen dred up whh pu unpreedened pressure on exernal aouns. The exhange rae depreaed sgnfanly agans S dollar and lqud foregn exhange reserves delned onsderably due o hgh wn def. In addon he role of exernal shoks n worsenng of domes eonom suaon anno be dsregarded. A sgnfan rse n nernaonal ommody pres n 28 has no only affeed negavely Paksan s rade balane bu also seeped no domes nflaon. Moreover ol mpors onrbue around 3 peren n Paksan s oal mpors and nrease n ol pre n nernaonal marke also pu pressure on exernal aoun. Therefore analyss of hese shoks n shapng n domes eonom ondon s enral n DSGE modelng. Table 2: Key Paksan Maroeonom Indaors FY8 - FY Q Q2 Q3 Q4 Q Q2 Q3 Q4 Q Q2 Q3 Q4 Q Q2 Q3 Q4 Inflaon a Inernaonal Ol b Pres Growh Rae Growh Rae of IPSM d Ineres Rae e (8.96) (9.) (9.37) (.33) (2.37) (3.36) (2.65) (2.94) (2.) (2.33) (2.5) (2.4) (2.43) (2.95) (3.46) (3.3) Fsal Balanes f (-2.69) (-.9) (-.9) (-2.9) Domes Deb g (33.) (3.88) (33.9) (34.82) Curren Aoun Balane h (-8.75) (-6.) (-2.35) (.27) Trade Balane (-3.2) (-.2) (-9.9) (-7.79) Exernal Deb j (28.32) (33.5) (32.67) (29.56) Inernaonal Reserves k (7.43) (7.9) (9.74) (9.27) Real Exhange Rae l (.3) (-.49) (-2.3) (-2.2) (-6.37) (-.64) (2.38) (.85) (2.45) (-2.7) (-.29) (5.44) (8.76) (.37) (6.94) (.84) Soure: Sae Bank of Paksan Noe: The Annual/Quarerly observaons menoned here orrespond o he fsal years; for example 28 s FY8. a Annual average growh rae of onsumer pre ndex (CPI). b Inernaonal Ol Pres (S$ per Barrel) Annual perenage hange n real gross domes produ (GDP). d YoY perenage hange n Indusral produon of arge Sale Manufaurng. e SBP Dsoun rae; fgures n parenhess are 6-monh T-bll rae. f Budge Balane as peren GDP; fgures n parenhess are prmary balane as peren GDP. g Domes deb n bllon of rupees;. fgures n parenhess are publ deb as peren of GDP h Curren Aoun Balane n Mllon of Dollars; fgures n parenhess are urren aoun as peren of GDP. Trade Balane n Mllon of Dollars; fgures n parenhess are rade balane as peren of GDP. j Exernal deb bllon of dollars; fgures n parenhess are exernal deb as peren of GDP. k Inernaonal reserves n bllons of dollars; fgures n parenhess are nernaonal reserves as peren GDP l Real effeve exhange rae (REER; a rse n he ndex ndaes appreaon of rupee); fgures n parenhess are perenage App/Depr. In hs sudy we nvesgae he mpa of varous exernal shoks - lke ol pre ommody pre Calvo shok (sudden sops) - vz-a-vz onvenonal domes shoks produvy shok governmen spendng shok moneary poly shok. The sgnfane of exernal shoks s evaluaed n he perspeve of he eonom sruure of Paksan. Paksan s a small open eonomy where rade o GDP rao sands a 4 peren ranked hrd afer Sr-anka and Inda n he regon- bu muh lower han Malaysa and oher Souh Asan ounres (see Fgure ). Imporanly exle and exle produs onrbue around 5 peren n overall Paksan s expors. Paksan s onsdered n -7-

9 op exle exporng ounres of he world and 4 h larges produer of oon yarn and lohs. In addon Paksan s also onsdered as 3 rd larges player n Asa wh a spnnng apay of 5 peren of oal world produon. ke oher ounres n he regon Paksan also sared o lberalze hough parally s apal aoun durng early 99s. In erm of fnanal openness based on he sum of foregn dre nvesmen (FDI) and porfolo equy nvesmens (PI) as peren of he GDPs Paksan s ranked hrd afer Malaysa and Inda whle s muh ahead of Bangladesh and Sr anka (see Fgure ). Fgure : Average Degree of Openness [FY FY] Malaysa Sr anka Egyp Turkey Inda Paksan Bangladesh Trade Openness Fnanal Openness Noe: Trade Openness: = (Expors + Impors)/GDP; Fnanal Openness: = (Foregn Dre Invesmen + Porfolo Invesmen) / GDP Daa Soure: Inernaonal Fnanal Sass IMF Daabase owever based on he average of Souh Asan ounres and he world Paksan falls shor n hs respe. On he oher hand Paksan s mpors are largely domnaed by peroleum and peroleum produs foods ems and Agrulure/hemal produs. Therefore any shoks o ommody and energy pre n nernaonal marke have a lkely mpa on domes mpors. Anedoal evdene suggess ha he mpa of suh shoks s no only observes n overall exernal aoun bu also emerges n domes nflaon. Ths evdene onfrms n a reen sudy by Khan and Ahmad (2) whle analyzng mpulse responses n maroeonom varables by nrodung a posve ol pre shok. They fnd ha an nrease n nernaonal ol pres no only pu pressure on domes urreny o depreae bu also nreases domes nflaon. Smlarly neres rae also ends o rse and domes eonomy wanes (see Fgure 2). Fgure 2: One sandard devaon shok o nernaonal ol pres Soure: Khan and Ahmed (2) -8-

10 Beng a small open eonomy Paksan reeved apal nflows largely n he shape of foregn remane foregn deb porfolo and foregn dre nvesmen. Imporanly Paksan has reeved sgnfanly large nflows of foregn apal durng 2s as ompared wh earler deades. nl FY4 hese nflows lmed o unrequed ransfers for nsane workers remane grans and logs suppors. Bu large apal nflows ook plae durng FY5 and onwards when governmen adoped proylal poles by gong soveregn allowng nsuons o generae funds from exernal soures prvazng more publ seor enerprses and fnanal nsuons and provde free aess o foregn nvesors n domes equy marke hus reang apal nflow bonanza. Imporanly wdenng urren aoun def remaned unnoed durng hs perod as healhy nflows no only fnaned burgeonng urren aoun def bu also resuled n aumulaon of foregn exhange reserves. owever hs rend seems no longer onnue durng FY8 and beyond. Calvo and Renhar (2) has rghly poned ou ha apal flow bonanzas should no be msaken as blessngs and grea harm s done when polymakers and nvesors sar reang he bonanza as a permanen phenomenon raher han a emporary shok. Fgure 3: Vulnerably of Sudden Sops GDP Growh (r.h.s) FDI Growh (l.h.s) Daa Soure: Annual Repors Sae Bank of Paksan. The reen delne n foregn nvesmen n Paksan and hen reversal of porfolo nvesmens s an obvous llusraon of Calvo shok (see Fgure 3). Imporanly he orgn of a apal aoun shok or sudden sop (SS) may be sysem and exogenous for nsane see Calvo e al. (24). The sysem sudden sop or 3S nally rggered by faors whh s exogenous o a ounry bu hen a weak eonom fundamenals and fnanal shallowness exaerbae he suaon and ulmaely lead o fullfledge SS (Calvo e al. 28). ndersandng hese dfferenes and arefully modelng he ransmsson mehansm of nernal and exernal shoks s rual o he desgn of sablzaon programs and he ondu of eonom poles. Anoher mporan haraers of Paksan s eonomy s he exsene of large nformal seor. Alhough he sze of nformal seors n erm of GDP renhed durng he las deades neverheless s sll hgh n he regon and as ompared wh oher developng ounres (see Table 3). As mos of he eonom aves n Paksan parularly agrulure are undoumened ha employed large poron of unsklled or parally sklled labor. Spefally Paksan s eonomy s onsdered agraran eonomy n erm of labor as around 7 peren of oal work fore s nformally employed n hs seor. In addon n erm of he sze of nformal seor as a peren of non-agrulure Paksan sands ou among he ompeng ounres (see Fgure 4). Spefally hs sze of 7 peren s slghly lower han IPIC ounres (sub-sahara regon) bu muh hgher ompared wh emergng Asan eonomes. Due o s large sze he mporane of nformal seor n desgnng of DSGE model anno be gnored. -9-

11 Table 3: Sze of Informal Eonomy (as peren of formal GDP) Malaysa* Sr anka* Egyp* Turkey* Inda* Paksan** Bangladesh* Average * Based on Shneder e al. (2) ** Based on Gulzar e al. (2) Fgure 4: Informal Employmen (as % of Non-Agrulural Employmen) 8% 7% 68.8% 7.% 72.6% 6% 5% 5.5% 5.2% 48.3% 55.8% 4% 3% 2% % % 7.4% 3.6% Soure: IO June 2 4. DESCRIPTION OF TEORETICA MODE Ths seon presens a mul-seor small open eonomy DSGE model for Paksan. Followng manly Gal and Monaell (25) Smes and Wouers (27) Medna and Soo (27) ader and Khan (28) and Ban e al. (2a) he model sruure begns wh he world-eonomy as nhabed by a onnuum of nfne-lved households (ndexed by j [] ) who ake desons on he onsumpon and savng n a sandard raonal opmzng manner. They hold real and fnanal asses and earn nome by provdng labor o dfferen ypes of frms workng n formal and nformal seors. There s a se of formal seor frms ha produe dfferenaed varees of nermedae radable goods. These frms produe goods usng labour apal and ol as npus. They have monopoly power over he varees hey produe and se pres n a saggered way. They sell her varees o assemblers ha sale a ompose home good n he domes and foregn markes. A seond group of formal seor frms are mporers ha dsrbue domesally dfferen varees of foregn goods. These frms have monopoly power over he varees hey dsrbue and also se pres n a Calvo (983) ype saggered Eah household lves n one of wo ounres ndvdual defned on he nerval j [ n] lves n he homeounry and remanng on he nerval j[ n] lves n he foregn-ounry. The value of n measures he relave sze of he home-ounry. --

12 fashon. A hrd group of frms s produng nformal non-radable nermedae goods. These frms do no pay any ax o governmen and relavely onsdered less produve as ompared wh formal seor frms. These frms produe varees usng labour and ol as npus and have monopoly power over he goods hey dsrbue and also se pres n a smlar saggered fashon. Along wh manufaurng of goods n boh formal and nformal seors agrulure produon s also akng plae. For smply s assumed ha ommodes produed n hs seor are ompleely expored abroad. The formal seor frms have aess o ren apal from apal leasng frms workng domesally and abroad. The res of he model assumes symmer preferenes and ehnologes and allowng poenally rh exhange rae and urren aoun dynams. Governmen n hs model deals wh fsal ssues and enral bank ondus moneary poly usng neres rae as a poly nsrumen. 4. ouseholds The domes eonomy s nhabed by a represenave household who derves s uly from onsumpon C real money balanes M / P C and lesure. Is lfe me preferenes are desrbed by an neremporal uly funon as: s s s s C s s () = s (.) = E u C M ( j) / P ( j) Where () s he neremporal dsoun faor whh desrbe rae of me preferenes E s expeaon operaor and P C s aggregae pre ndex for ore onsumpon bundle. In hese preferenes we nrodue exernal hab formaon n onsumpon for he opmzaon household as C = C( j) hc wh degree of nensy ndexed by ĥ where C s he aggregae par of onsumpon ndex. The funonal spefaon of uly funon u s s gven as: M M s( j) s( j) us C s M s ( j) / PC s s ( j) = C s log( Cs ( j) hc s ) s P C s In hs spefaon C s onsumpon preferene shok (a knd of ase shok) s he semelasy of money demand o nomnal neres rae M s relave wegh assgn o real money balanes s he nverse of wage elasy of labour supply and s s a labour supply shok. As usual s assumed ha and. I s also assume ha us C s M s( j) / PC s s( j) s an nreasng funon wh dmnshng reurns n eah of s argumens. The household does wan o maxmze s uly level subje o he followng budge onsrans a me : M ( ( )) ( j) E Q D j B ( j) C ( j) PC PC ( ) (ß ) PC (2) W ( j) ( j) D ( j) M ( j) B ( j) TR P = P P P P P P C C C C C C Where Q s defned as a sohas dsoun faor for assessng onsumpon sreams 2 (or asse pre kernel) wh he propery ha he pre n perod of any bond porfolo wh random values I also shows hab perssene parameer o reprodue observed oupu rages from hˆ. 2 In erms of hs dsoun faor he rskless shor erm nomnal neres rae R orresponds o he soluon o he equaon: / ( ) E ( Q ). --

13 D (denoes nomnal payoffs from a porfolo of asses a me -) n he followng perod s gven by: B E [ Q D ]. 3 W s he nomnal wage for labour serves provded o frms s nomnal exhange rae and B s foregn bond holdngs wh rae of reurn. In hs budge onsran (.) = s he premum ha domes household have o pay when hey borrow from abroad. The premum s a funon of he ne foregn asse posons relave o gorss domes produ (GDP) and ' defne as: ß = B / PY Y. The premum funon also sasfes wo properes: (.) = and ( / ) ß =. Fnally TR s nomnal ransfer and P s nomnal lump-sum ax whh every household have o pay o governmne. The household opmzaon proess solves he followng angrangan funon as: s Max = E C s M s s D s B s = s M M s( j) s( j) C s log( Cs ( j) hc s ) s P C s Ws ( j) s ( j) Ds ( j) M s ( j) sbs ( j) TR s Ps PC s PC s PC s PC s PC s PC s s ( j) M ( ) Es( Q s j s sds( j)) sbs( j) Cs ( j) PCs PCs ( s ) (ß s ) P C s The soluon o hs problem yelds he followng frs order ondons (FOCs): ( j) = C ( j) hc C M( j) ( j) P C C M = ( j) E P C ( j) PC W ( j) ( j) ( ( )) = C s j P E C ( j) ( j) = Q PC PC ( j) ( j) E = C ( P ) (ß ) PC The above FOCs an furher smlfy by solvng hem smulanously and yeld four mporan resuls neremporal Euler equaon of onsumpon real money demand equaon labour supply funon and unovered neres pary ondon. The Euler equaon of onumpon s gven as: where EQ = E The real money demand funon s gven as: P C ( j) hc C C ( ) = PC C C ( j) hc The labour supply funon s gven as: C M M ( j) = P C ( j) hc ( ) (3) (4) 3 Q remans a sohas varable a me and E denoes expeaons ondonal upon he sae of he world a me. -2-

14 W ( j) ( ( j)) = P C ( j) hc Fnally he unovered pary ondon s gven as: C P C hc ( ) ( ) (ß ) P C hc C C E P C C = C hc C C E P C C C hc (5) sng he fa ha: EQ = EQ so smplfes as: ( ) = E ( ) (ß ) Ths equaon mples ha he neres rae dfferenal s relaed wh expeed fuure exhange rae depreaon and nernaonal rsk premum whh defned as un-overed neres pary ondon. (6) 4.. ousehold Consumpon Desons The aggreagae onsumpon bundle for he jh household s a ompose of ore onsumpon bundle and ol onsumpon. Is omposon s gven by he onsan elasy of subsuon (CES) aggregaor: / / ( ) = Z ( ) ( ) O ( ) C j C j C j (7) Where s he elasy of neremporal subsuon beween ore onsumpon and ol onsumpon bundle. arger he value of mples ha goods are loser subsues. measures he proporon (persenage share) of ore goods n he onsumpon of households. If s value equals o one hen mples households only onsume ore goods and here s no ol onsumpon akng plae. The represenave household ams a maxmzng he uly from onsumpon of boh goods by mnmzng he expendure on hese wo varees whle manang a eran arge level of onsumpon. Solvng hs problem of opmal alloaon of expendure on ore and ol goods yelds he followng demand funons for hese goods. P Z Z ( ) = ( ) P C C j C j P O O ( ) = ( ) ( ) P C C j C j Where P z and P o are pres of ore and ol onsumpon bundles. P s he aggregae onsumer pre ndex (CPI) and defned as: = ( ) C Z O P P P The ore onsumpon goods are produed eher n he formal seor or n undoumened (also known as: nformal or hdden) seor. Therefore he onsumpon of hs bundle s deermned by a CES ndex omposed of formal seor goods and nformal goods as follows: (8) (9) () -3-

15 / / Z ( ) = D ( ) ( ) ( ) C j C j C j () Where s he elasy of neremporal subsuon beween formal goods onsumpon and nformal goods onsumpon bundle. arger he value of mples ha goods are loser subsues. measures he proporon (persenage share) of formal seor goods n he ore onsumpon of households. As wh he ase of oal onsumpon above expendure mnmzaon problem on he ore onsumpon goods yelds he followng demand funons for he formal seor and nformal seor goods. P D D Z P Z C ( j) = C ( j) P Z P Z C ( j) = ( ) C ( j) Where P D and P are pres of formal and nformal onsumpon bundles. P z s he aggregae pre ndex of ore onsumpon bundle and gven as: = ( ) Z D P P P The formal seor onsumpon bundle s gven by he followng CES aggregaor of home and foregn goods: / / D ( ) = ( ) ( ) F ( ) C j C j C j Where s he elasy of neremporal subsuon beween home goods onsumpon and foregn goods onsumpon bundle. arger he value of mples ha goods are loser subsues. measures he proporon (persenage share) of home goods n he formal goods onsumpon by he households. As wh he ase of ore onsumpon above expendure mnmzaon problem on he ore onsumpon goods yelds he followng demand funons for he home and foregn goods. P D P D C ( j) = C ( j) P F F D P D C ( j) = ( ) C ( j) Where P and P F are pres of home and foregn onsumpon bundles. P D s he aggregae pre ndex of formal onsumpon goods and gven as: 4..2 ousehold abour Supply Desons = ( ) D F P P P In hs model a fraon of households provde labor o formal seor frms and res of hem (- ) provde labor o nformal seor. The aggregae labour s gven by he followng CES aggregaor of formal seor labour D and nformal seor labour. (2) (3) (4) (5) (6) (7) (8) ( ) = ( ) ( ) j D j ( j) (9) -4-

16 Where s he nverse elasy of neremporal subsuon beween formal and nformal seor labour. The household opmzaon problem based on wage earnngs yelds he followng supply funons for he formal and nformal labour: W ( j) / P D D D ( j) = ( j) W ( j) / P Z ( j) = ( ) ( j) W ( j) / P Z -5- W ( j) / P Where W D and W are nomnal wages n he formal and nformal seor respevely. W s he aggregae wage ndex whh s defned as: W j W j W j ( ) = D ( ) ( ) ( ) The supply funons (2) and (2) show ha supply of eah ype of labor depend on relave wage of respeve labor and on aggregae labor supply. The smulaneous soluon o above supply funons wh aggregae wage ndex yeld followng real wage funons: P D D ( ) / D = ( ) / Z P Z W j P W j P P ( ) / = ( ) ( ) / Z P Z W j P W j P Followng Ahmad e al. (22) we assume ha formal labor s a ompose of labor dfferenaed on bass of dfferen levels of skll represened by s. sng hs assumpon aggregae formal labor supply an aken as: = D D ( s) ds (25) Where s he elasy of subsuon beween dfferen labor sklls n he formal seor. sng hs aggregaor s easy o defne aggregae wage n he formal seor as: = D D ( ) W W s ds (26) Ths ondon allows eah household o have some marke power o se wages on bass of s skll s. Therefore household opmzes followng wage nome funon as: Max W ( s) ( s) W ( s) (27) W D ( s) D D D D The soluon o hs problem yelds he followng wage markup ondon: 4.2 Capal easng Frm and Invesmen Desons W ( s) = W D D There s a represenave apal leasng frm ha rens apal goods o formal seor frms produng nermedae varees. Due o formal doumenaon and legal requrmens hs frm does no nra wh nformal seor frms. I also dedes how muh apal o aumulae eah perod n he formal (2) (2) (22) (23) (24) (28)

17 seor. New apal goods are assembled usng a CES ehnology ha ombnes home and foregn goods as follows: Where D I I I I / I I I / I I I D = I ( ) ( I ) ( F F ) I I I (29) I s he oal prvae nvesmen n he formal seor. s he elasy of neremporal subsuon beween home and foregn nvesmen goods and measures he proporon (persenage share) of home goods n oal foraml seor nvesmen. The nvesemen opmzaon problem yelds he followng demand funons for he home and foregn goods: I P I I = I I D P I I P I F F IF = ( I ) I D P I I I Where and F are shoks o he domes nvesmen and foregn nvesmen respevely whh are assumed o follow frs-order auoregressve proesses wh IID-Normal error erms: I I I I I I I and F I F F. PI s he aggregae pre ndex of oal nvesmen and gven as: F = I I ( ) I I I I F P P P As n Smes and Wouers (23 27) and Chrsano e al. (25) we nrodue a delayed response of nvesmen observed n he daa. Capal leasng frm ombne exsng apal D I from he enrepreneurs o ransform an npu D gross nvesmen no new apal aordng o: funon () K = I S I ( ) K I D D D D I D K (3) (3) (32) leased Where I D s gross formal seor nvesmen s he depreaon rae and he adjusmen os S s a posve funon of hanges n nvesmen. S() equals zero n seady sae wh a onsan nvesmen level [ () S and S g y = ]. In addon we assume ha he frs dervave also equals zero around equlbrum so ha he adjusmen oss wll only depend on he seond-order ' '' dervave ( S (.) = S (.) = s < ) as n Chrsano e al. (25). We also nrodued a shok o he oal nvesmen whh s assumed o follow a frs-order auoregressve proess wh an IID-Normal I I I error erm: I. Formal seor frms hoose he apal sok and nvesmen n order o maxmze her prof funon. e s he renal pre of apal. The represenave formal seor frm mus solve he followng opmzaon problem: Z K P I (34) D I D Max E (33) K D I D = PC The frs-order ondons resul n he followng wo equaons: -6-

18 P Q I I I = S S P P I I I I D ' D D C C D D D Q I I E S ' D D I P C I D I D 2 I Q Z Q = E ( ) P P P C C C (35) (36) These equaons samulanously deermne he evoluon of he shadow pre of apal nvesemen expendure. and real 4.3 Domes Formal Seor Produon In domes formal seor here are hree ypes of frms: domes formal seor realers nermedae goods produng frms and mpor goods realers. Domes formal seor realers are ne buyers of domes nermedae varees produed by domes nermedae goods produng frms and assemble hem as fnal home goods. These frms sell a quany of formal home goods n domes formal goods marke and also expor remanng quany abroad. Impor goods realers on he oher hand purhase foregn goods a world marke pres and sell o domes onsumers. These frms harge a markup over her os whh reaes a wedge beween domes and mpor pres of foregn goods when measure n he same urreny Formal Seor Realers Realers n he formal seor produe a quany of home goods Y sold domesally and Y he quany of goods sold abroad. These quanes of fnal goods are assembled usng CES ehnology wh a onnuum of nermedae goods Y ( z ) and Y ( z ) respevely as: = ( ) Y Y z dz (37) = ( ) Y Y z dz (38) Where s he elasy of subsuon beween dfferenaed formal nermedae varees. nder he assumpon of perfely ompeve envronmen he prof funon for boh quanes of fnal goods an be wren as: = ( ) P Y P ( z ) Y ( z ) dz (39) = ( ) P Y P ( z ) Y ( z ) dz (4) Where s he fla ax rae on fnal goods P ( z ) s he pre of varey Z when used o assemble home goods sold n he domes marke and P ( z ) -7- s he foregn urreny pre of hs

19 varey when used o assemble home good sold abroad. Formal seor realers ry o opmze her prof funons whle akng deson on how muh nermedae varey Z o purhase gven s pre and demand elasy. Ths opmzaon problem yelds he followng demand funons for he parular nermedae varey Z as: P ( z ) Y ( z ) = Y ( ) P P ( z ) ( ) = ( ) P Y z Y (4) (42) Inermedae Goods Produon n he Formal Seor In he formal seor here s a se of monopols ompreve frms whh produe nermedae goods usng labour apal and ol as key npus. These frms maxmze profs by hoosng he pres of her dffereaed good subje o he orrespondng demands and he avalable CES ehnology of he followng ype: Where / / ( z ) = A V ( z ) ( ) O ( z ) A s he exogenous level of ehnology avalable o all frms V ( z ) s a ompose of labour and apal npus used n he produon proess and O ( z ) s he amoun of ol npu used n produon of nermedae varees. In hs ehnology s he elasy of neremporal subsuon beween ol and oher faor of npus. arger he value of mples ha ol and oher faor of mpus are loser subsues. measures he proporon (persenage share) of non-ol faor npus n he produon of nermedae varees. The ompose of labour and apal s gven by he followng Cobb-Douglas ehnology: (43) D D D V ( z ) = [ T ( z )] [ K ( z )] (44) Where ( ) D z s he amoun of domes formal labour beng used n he formal seor produon and KD ( z ) s he amoun of physal apal rened from apal leasng frm. In hs Cobb-Douglas ehnology represens labour share and T D represens sohas rend n he labour produvy and evolves aordng o he follwng expresson: T T D D = DT (45) The aggregae ehnology shok n CES ehnology (43) and formal seor labour produvy shok n Codd-Douglas ehnology (44) are defned n he followng manner: a a A = A exp( ) and DT DT DT g y DT DT = ( ) exp( ) Where a DT are sohas respeve d nnovaons and A DT DT are respeve perssene levels. Followng Calvo (983) saggered-pre seng s assumed. Ths means ha domes -8- a

20 formal seor dfferenang goods are defned subje o Calvo-ype pre-seng. In hs seup a eah perod only fraon of randomly seleed domes frms se pres opmally for domes marke and fraon of randomly seleed domes frms se pres opmally for foregn marke whle remanng frms keep her pres unhanged 4. As a resul he average duraon of a pre onra s gven by / ( ) for domes marke and / ( ) for foregn marke. Ths mples ha f a frm does no reeve a sgnal revses s pre followng a smple rule ha weghs pas nflaon and he nflaon arge se by he enral bank. 5 Therefore when a frm reeves a sgnal o adjus s pre for domes formal marke hen solves he followng opmzaon problem: P ( z ) MC Max ( ) (46) E Y z P ( z ) = PC Subje o demand onsran (4) and updang rule for pres. Smlarly when a frm reeves a sgnal o adjus s pre for foregn marke hen solves he followng opmzaon problem: * ( ) P z MC Max E Y ( z ) P ( z ) (47) = PC Subje o demand onsran (4) and updang rule for pres. In above expressons (46) * MC and (47) s he nomnal margnal os whh s defned as follow: MC WD D ( z ) Z KD ( z ) PO O ( z ) = ( z ) (48) Gven hs pre sruure he opmal pah for nflaon s gven by a New-Keynesan Phllps Curve wh ndexaon Impor Goods Realers n he Formal Seor In he formal seor here s a se of ompeve assemblers ha use a CES ehnology o ombne a onnuum of dfferenaed mpored varees o produe fnal foregn good Y F. The CES aggregaor s gven as: F F F F F = F ( F ) F Y Y z dz (49) Where F s he elasy of subsuon beween dfferenaed formal nermedae mpored varees. nder he assumpon of perfely ompeve envronmen he prof funon for mpored 4 frms adjus pres aordng o seady sae nflaon rae. Ths noon nrodues nflaon perssene by allowng for pre ndexaon o prevous nflaon. 5 The degree of pre skness s assumed o be same as he fraon of pas nflaon ndexaon. The reason of hs rude assumpon s ha valdaes a bas raonale of Phllps urve. In he long-run Phllps Curve s veral see for nsane Gal and Gerler (999). -9-

21 fnal goods an be wren as: Where F F F F F F F F F F = ( ) P Y P ( z ) Y ( z ) dz (5) s he fla ax rae on mpored fnal goods P ( z ) s he pre of varey Z F when used o assemble mpored goods sold n he domes marke. Formal seor mpor realers ry o opmze her prof funons whle akng deson on how muh nermedae mpored varey Z F o purhase gven s pre and demand elasy. Ths opmzaon problem yelds he followng demand funon for mpored varey Z F as: F P ( z ) Y ( z ) = Y ( ) F F F F F F F P F Followng Gal and Monaell (25) and Monaell (25) s assumed ha he law-of-one pre (OP) holds a he wholesale level for mpors. Bu endogenous fluuaons from purhasng power pary (PPP) n he shor run arse due o he exsene of monopolsally ompeve nermedae varey mporers. Sne hey keep domes mpor pres over and above he margnal os. As a resul he OP fals o hold a he real level for domes mpors. Imporers purhase foregn goods a worldmarke pres P * ( z ) so ha he law of one pre holds a he border. These purhased foregn goods are F F hen sell o domes onsumers and a mark-up s harged over her os whh reaes a wedge beween domes and mpor pres of foregn goods when measured n he same urreny. 6 Now followng a smlar saggered-prng argumen (46) as defned n he ase of domes formal seor produer he opmal pre seng behavor for he domes monopolsally ompeve mporer ould be defned as: P ( z ) P ( z ) Max ( ) (52) F F F F F E F YF zf P F ( z ) = PC Imporng frms ry o opmze (52) subje o demand onsran (5) and use updang rule for pres as F. 4.4 Domes Informal Seor Produon In hs model seup s assume ha along wh domes formal seor nformal produon s also akng plae. There are wo ypes of frms: domes nformal seor realers and nformal nermedae goods produng frms. The nformal realers are workng n a symmer fashon o he formal seor realers. The only wo exepons dsngush her role from formal o nformal ha hese realers pay no axes and an only use nermedae varees produed n he nformal nermedae goods produng seor Informal Seor Realers F (5) Realers n he nformal seor produe a quany of goods Y whh s ompleely onsumed domesally. Ths quany of nformal fnal goods s assembled usng CES ehnology wh a onnuum of nformal nermedae varees Y ( z ) as: 6 If PPP holds hen l.o.p gap mples ha pass-hrough from exhange rae movemens o he domes urreny pres of mpors s mperfe as mporers adjus her prng behavor o exra opmal revenue from onsumers. See for nsane Monaell (25). -2-

22 = ( ) Y Y z dz (53) Where s he elasy of subsuon beween dfferenaed nformal nermedae varees. nder he assumpon of perfely ompeve envronmen he prof funon of fnal nformal goods produng realer an be wren as: = P Y P ( z ) Y ( z ) dz (54) Where P ( z ) s he pre of varey Z when used o assemble nformal goods sold n he domes nformal marke. Informal seor realers ry o opmze her prof funons whle akng deson on how muh nermedae varey Z o purhase gven s pre and demand elasy. Ths opmzaon problem yelds he followng demand funon for he nermedae varey Z as: P ( z ) ( ) = P Y z Y Inermedae Goods Produon n he Informal Seor Smlar o formal seor here s a se of monopols ompreve nformal frms whh produe nermedae goods usng labour and ol as key npus. owever hese frms have no aess o ren apal as an npu of produon. These frms maxmze profs by hoosng he pres of her dffereaed good subje o he orrespondng demands and he avalable CES ehnology of he followng ype: / / ( z ) = A V ( z ) ( ) O ( z ) (56) Where A s he onsan exogenous level of ehnology avalable o all nformal seor frms. I s also assumed ha hese frms are less produve as ompared wh formal seor frms. In he produon ehnology of hese frms V ( z ) s a ompose of labour npu only and O ( z ) s he amoun of ol npu used n produon of nermedae nformal varees. Furhermore s aken as he elasy of neremporal subsuon beween ol and oher faor of npus. arger he value of mples ha ol and oher faor of mpus are loser subsues. measures he proporon (persenage share) of non-ol faor npus n he produon of nermedae nformal varees. The labor ompos s gven by he followng form: V ( z ) = [ T ( z )] (57) Where ( ) z s he amoun of domes nformal labour beng used n he nformal seor produon. In hs ompose ehnology T represens sohas rend n he nformal labour produvy and evolves aordng o he follwng expresson: T = T (58) T I s assumed ha nformal labor s less produve ( T < T ) and labour produvy shok D T s defned as: T T T g y T T where T s sohas d nnovaons and = ( ) exp( ) (55) -2-

23 T T s respeve perssene levels. Smlar o formal seor frms s also assumed ha nformal seor frms se pres aordng o Calvo (983) saggered-pre seng sheme. Ths mples ha a eah perod only fraon of randomly seleed domes nformal seor frms se pres opmally for domes nformal marke whle remanng nformal seor frms keep her pres unhanged. As a resul he average duraon of a pre onra s gven by / ( ) for domes nformal marke. Ths mples ha f any nformal seor frm does no reeve a sgnal revses s pre followng a smple rule ha weghs pas nflaon and he nflaon arge se by he enral bank. Therefore when hs frm reeves a sgnal o adjus s pre for domes formal marke hen solves he followng opmzaon problem as: P ( z ) MC Max E Y ( z ) (59) P ( z ) = PC Subje o demand onsran (55) and updang rule for pres. In hs expresson MC s he nomnal margnal os whh s defned as followng: W ( z ) PO O ( z ) MC = (6) ( z ) Gven hs pre sruure for nformal frms he opmal pah for nflaon s gven by a New- Keynesan Phllps Curve wh ndexaon. 4.5 Agrulure Commody Produng Seor In hs model aggrulure produon s also akng pale along wh he manufaurng of formal and nforaml goods. I s assumed ha here s sgle frm produes a quany of homogenous aggrulure ommodes ha s ompleely expored abraod. Produon ehnology evolves wh he same sohas rend as oher aggregae varables and requres no npus as: Where S Y T S Y S S S T S Y s T = exp( ) s oal aggrulure oupu Y s sohas d ehnology and s (6) Y S represens perssene of shok n aggrulure oupu. As here s no faor npu n hs produon proess so an nrease n aggrulure ommody produon mples drely an nrease n domes oupu. Ths nrease n produon an be aken as a wndfall gan. I also may nrease expors f no ounerang effe on home goods expors domnaes. We would expe ha as wh any nrease of ehnologal froner of radable goods a boom n hs seor would ndue an exhange rae appreaon. asely s also assumed ha aggrulure produon s posvely relaed wh nformal labour produvy ndrely hrough prduon pssbly froner. 4.6 Moneary Poly I s assumed ha moneary auhory follows Taylor-ype reaon funons. Sne he bas objeve of he enral bank s o sablze boh oupu and nflaon. So n order o spefy hs reaon funon needs o adjus nomnal neres rae n response o devaons of nflaon a measure of oupu and exhange rae depreaon from her arges. Followng Clarda Gal and Gerler (2) and Gal and Monal (25) smple open eonomy verson of reaon funon s defned as: ( ) y ( ) ( ) rer Y C r r Y RER = exp( m ) r r Y Y RER (68) -22-

24 Where C = ( PC ) / PC s oal onsumer pre ndex and r = ( ) / ( C ). The parameer s he degree of neres rae smoohng and ( ) ( ) and ( ) are relave weghs on oupu nflaon and real exhange rae respevely. m s d-nnovaon defned as a moneary poly shok. 4.7 Fsal Poly In hs model seup governmen fnanes s expendures by segnorage (prnng money M M ) and mposng lump-sum ax P on households and fla axes on fnal goods produed n he domes formal seor as P Y and on mpored goods from abroad as F PF YF. These expendures are onssng of spendng on goods and serves G y P G and makng lump-sum ransfers o households TR. The def n any ase s fnane usng foregn bonds G and domes bonds G on whh pays neres bak as well. Therefore he governmen s budge onsran an be wren as: B rer B B B P G = B B ( ) ( ) ( ) G G B PY Y G G G P Y P Y ( M M ) TR F F F P (62) We assume ha he baske onsumed by he governmen nludes boh home G and foregn goods G F. Is omposon s gven by he onsan elasy of subsuon (CES) aggregaor: G G G G / G G / G G = G ( G ) F G G G Where s he elasy of neremporal subsuon beween home and foegn onsumpon good. arger he value of mples ha goods are loser subsues. measures he proporon (persenage share) of home good n governmen onsumpon goods. If s value equals o one hen mples governmen only onsume home good and here s no foregn good onsumpon akng plae. The governmen dedes he omposon of s onsumpon baske by mnmzng s os. Solvng he os opmzaon problem of opmal alloaon of governmen expendure yelds he followng demand funons: (63) G G G P = G G P G G P F F = ( G ) G P G (64) (65) Where he deflaor of governmen expendure s gven by: = G G ( ) G G G G F P P P (66) -23-

25 Fnally s assumed ha governmen follows a smple srural fsal balane rule aordng o whh governmen aggregae expendure as peren of GDP evolves as follows: PG G BG PY Y = exp( G ) PY Y PY Y ( ) PY Y PY Y (67) Where G s exogenous governmen spendng shok defned as a auoregressve of order one proess wh d nnovaon. 4.8 Foregn Seor Eonomy Agens n he foregn seor eonomy demand boh he agrulure ommody goods and formal seor home goods. The demand for he agrulure ommody good s assumed o be ompleely elas a he nernaonal pre P S. If he law of one pre holds for hs good hen s domes-urreny pre an be defned by: P = P (69) S S Smlar o prng assumpon of agrulure ommodes n he nernaonal marke we assumed ha demand for ol ommody s ompleely elas a he nernaonal pre O law of one pre holds hen he ol pre n domes urreny s gven as: P = P O O P and f he The real exhange rae s defned as he produ of nomnal exhange rae wh relave pre of a foregn pre ndex P and he pre of he onsumpon bundle n he domes eonomy P C : RER P = PC As usual he foregn pre ndex s no neessarly equal o he pre of mpored goods. owever under he assumpon of long-run relaonshp we an wre as: P = P (72) F F Where F s a saonary ransory shok o he relave pre of mpors abroad. Ths shok may be relaed o hanges n he relave produvy aross seor n he foregn eonomy. Foregn demand for home goods depends on he relave pre of hs ype of goods abroad and he oal foregn aggregae demand: P Y = ( ) Y (73) P Where orresponds o he share of domes nermedae goods n he onsumpon baske of foregn agens s he pre elasy of he demand and he foregn oupu. Ths demand an be obaned from a CES uly funon wh an elasy of subsuon aross varees equal o ha parameer. 4.9 Aggregae Equlbrum sng he above model seup we an drve general equlbrum dynams around her seady-sae level. The general equlbrum s aheved from goods marke equlbrum and labour marke equlbrum. The goods marke equlbrum derved from aggregae demand sde fores and labour marke equlbrum Y (7) (7) -24-

26 dynams emerge from aggregae supply sde fores. So he general equlbrum of he whole model s aheved from hese marke equlbrums and key equlbrum resuls are gven as: P ( z ) P ( z ) ( ) = z Y Y ( ) P ( ) P (74) Where he aggregae resoure onsran of he formal seor s defned as: Y = C I G (75) The above aggregae equlbrum mples ha oal labor demand by nermedae varees produers n he formal seor mus be equal o labor supply mpled n hs seor. Sne eonomy s nerang wh he res of he world herefore foregn demand for home goods depends on he relave pre of hese formal seor goods abroad and he oal foregn aggregae demand s defned as: P Y = ( ) Y (76) P Where s aken as he share of domes nermedae formal seor goods used n he onsumpon baske of foregn agens * s he pre elasy of he expor demand funon and s he aggregae foregn oupu. nder eran assumpon hs demand an be derveed from a CES uly funon wh an elasy of subsuon aross nermedae arees equal o ha parameer. Smlar o formal seor aggregae equlbrum ondons as jonly defned n (77) and (75) he equlbrum nformal seor equaes nformal oupu o nformal onsumpon. P ( z ) ( z ) = Y P Ths equlbrum also mples ha oal labor demand by nermedae varees produers n he nformal seor mus be equal o labor supply mpled n hs seor. Therefore he aggregae resoure onsran of nformal seor s gven as: Y (77) Y = C (78) The jon ombnaon of goods marke equlbrum ondons he budge onsran of he governmen and he aggregae budge onsran of households s easy o oban an expresson for he aggregae aumulaon of nernaonal bonds: BG / PY Y P X X P M M B = (79) B PY Y PY Y PY Y ( ) ( ) P Y Y Ths expresson also shows ne foregn asse poson of he exernal seor of he eonomy. Correspondng o hs expresson wh pre deflaor o eah aggregae demand omponen he oal GDP a urren pres an be defned as he followng relaon: P Y = P C P G P I P X P M (8) Y C G I X M Fnally he oal value of nomnal expors and he oal value of nomnal mpors are gven by: = ( P X P Y P Y ) (8) X F s s P M = ( P Y P ( C O O )) (82) M F F O O Where aggregae resoure onsran n erms of Y F an be defned as: Y = C I G (83) F F F F -25-

27 4. Alernave Moneary Poly Rules and Welfare We analyze he lkely mpa of alernave moneary poly rules based on soal welfare loss funon mnmzaon. Among varous moneary poly regmes he opmal moneary poly or Ramsey poly rule s defned by maxmzng he neremporal household welfare ( ) subje o a se of non-lnear sruural onsrans of he model. To be more prese a Ramsey equlbrum s a ompeve equlbrum suh ha: () Gven a sequene of shoks pres poly nsrumen and quanes P ; R ; Q maxmzes he represenave agen lfeme uly. () r >. In order o analyze essenally he maroeonom sablzaon properes of he moneary poly we assume subsdes on labor and goods markes are offseng frs order dsorons. In ha ase he flexble pre equlbrum s Pareo opmal. The Ramsey poly problem s wren usng an nfne horzon agrangan: Where J j 2 E r ( r j r ) j (Model Consrans) (84) ( ) y ( ) ( ) rer Y C r r Y RER = r r Y Y RER and M M = C log( C hc ) P C In above agrangan funon r s he wegh assoaed o he os on neres rae fluuaons. We nrodue an neres rae objeve n hs problem n order o make he Ramsey poly operaonal. Followng Woodford (24) Gal (28) and Walsh (2) we wll ake seond order approxmaon of he agens lfeme expeed uly funon hrough Taylor s seres. 7 In hs framework he enral bank res o maxmze he soal welfare when here s a rade-off beween he aggregae onsumer pre nflaon and he hanges n oupu. Frs we an wre he approxmae uly of onsumpon as: log( C hc ) ( h) C ( C hc ) (85) We an also wre he dsuly of labor abou s flexble pre equlbrum as: ( ) 2 ( 3 n n o a ) 2 Y P ( j) Where d ( D ) A. P sng hese resuls wh opmzaon ondon we an wre he seond order approxmaon o he small open eonomy s uly funon as follows: (86) 7 A seond-order log-lnear approxmaon o he funon ( ) around s seady sae ( ) s gven by: log 2 3 e [log log ] [log log ] o( a ). In general f s devaon of ( ) around 2 s seady sae ( ) and ˆ log( / ) s log-devaon of ( ) around s seady sae ( ) hen seond order 2 3 approxmaon an be obaned as: ( ˆ ˆ ) o( a )

28 C 2 flexble 2 3 W E ˆ ˆ ˆ C ( )( y y ) o( a ) (87) Takng unondonal mean and leng he expeed welfare loss of any poly ha devaed from Ramsey poly an be wren n erms of varanes of nflaon and oupu gap as: soal C 2 flexble 2 W E ˆ ˆ ˆ var( C ) ( ) var( y y ) (88) Gal and Monaell (25) and Alba e al. (22) sudes argued ha ha usng hs soal welfare maxmzaon rera along wh he assumpons of purhasng power pary and unovered neres pary he ombned effes of marke power and erms of rade dsorons ould be offse so ha under flexble pre equlbrum. In hs framework domes nflaon argeng s he opmal moneary poly. owever apar from domes nflaon argeng n a sr sense enral banks n mos of emergng marke eonomes pu wegh o some oher seondary objeves of moneary poly lke eonom growh sably and smoohng of exhange rae fluuaons. Therefore opmal moneary poly n suh developng eonomes s one produe mnmum welfare loss of he enral bank. Therefore he opmal moneary poly rule under Ramsey poly framework s haraerzed as: ( opmal ) y opmal ( opmal ) opmal ( ) opmal rer opmal C r r Y Y RER = r r Y Y (89) RER Ths framework measures welfare loss as a seond order approxmaon o he uly loss of he domes onsumer resulng from devaons from opmal moneary poly. Followng uas (987) and Woodford (24) alernave moneary poles regmes are spefed n he onex of a smple DSGE model and he welfare losses are ompared o draw poly mplaons. In hs paper we have also onsdered four alernave moneary poly regmes along wh opmal moneary poly rule. The frs alernave poly regme s onsdered as less aggressve an-nflaon poly. Ths regme pu less wegh o nflaon and assgned zero wegh o boh hanges n oupu and exhange raes fluuaons. The poly rule assoaed wh hs regme an be defned as: ( ) r r C = r r (9) The seond alernave moneary poly regme s onsdered as more aggressve an-nflaon poly. Ths regme pu relavely more wegh o nflaon and assgned zero wegh o boh hanges n oupu and exhange raes fluuaons. The poly rule assoaed wh hs regme an be defned as: r r C = r r ( ) 2 where 2. (9) The hrd alernave moneary poly regme s aken n whh enral bank pu less wegh o hanges n oupu ogeher wh pre sably objeve. owever hs regme assgns zero wegh o exhange raes fluuaons. The poly rule assoaed wh hs regme an be defned as: ( ) y ( ) r r Y Y C = r r Y Y The forh alernave moneary poly regme s aken n whh enral bank pu more wegh o hanges n oupu ogeher wh pre sably objeve. Smlar o prevous alernave regmes hs poly rule assgn zero wegh o exhange raes fluuaons. The poly rule assoaed wh hs regme an be defned as: ( ) y2 ( ) r r Y Y C = r r Y Y (92) where y2 y. (93) -27-

29 5. NMERICA SOTION AND CAIBRATION RESTS The model s solved numerally usng he general mehodology as provded n hlg (999) Klen (2) and Sms (22). In order o oban numeral soluons s requred frs o ransform model s omplee se of non-lnear equlbrum relaons o s log-lnearzed form. Ths s done by akng frs order Taylor approxmaons o eah equlbrum ondon around s seady sae pah. A bref desrpon of hs approah along wh log-lnearzed equlbrum ondons are provded n Appendx-A. The numeral soluons are hen obaned by employng he mehod of undeermned oeffens. Ths sep onsders he auoregressve shoks as key exogenous proesses. Our DSGE model onsss of sxeen exogenous shoks among whh nne are domes and res are propagaed from exernal soures. Based on he propagaon mehansm of hese shoks numeral algorhm ompues model empral momens mpulse responses of endogenous varables o eah exogenous proess and varane deomposon resuls. These resuls allow us o examne he empral f of he model and o undersand he behavor of eonomy o varous sruural shoks. 5. Model Parameerzaon Model parameerzaon sep requres assgnng numbers o sruural parameers of he model. We albrae he model a quarerly frequeny wh he hoe of parameer values ha are approxmaely onssen wh key feaures of developng eonomy n general and Paksan s eonomy n parular. Almos all parameer values used n hs model have nally been albraed usng paral esmaon approah. The res of few parameer values whose daa for esmaon s unavalable are hen aken from he exsng DSGE/RBC leraure on emergng marke eonomes. The hosen values of hese parameers an be gleaned from personal nrospeon o refle srongly held belefs abou he valdy of eonom heores. Therefore he seleon mus refle researher onfdene abou he lkely loaon of sruural parameer of he model. In our model here are fory-hree sruural and hry-wo shok relaed parameers. The esmaed values of sruural parameers are gven n Table C whereas values o he shok relaed parameers are gven n Table C2 of Appendx C. The frs aegory of sruural parameers s relaed o household preferenes. The parameer value of dsoun faor ( ) s aken as.99. Ths value s onssen wh he quarerly esmaes of dsoun faor for Paksan eonomy as gven n Ahmed e al. (22). Ths value s se n order o oban hsoral mean of real neres rae n he seady sae. Ahmed e al. (22) esmaes sugges ha he long run real neres rae s lower n mos of developng ounres. Therefore he seleed parameer value of neremporal dsoun faor s que useful for our model albraons as our prme onern s o replae busness yle fluuaons of a developng eonomy lke Paksan. The degree of exernal hab perssene ( ĥ ) n onsumpon s se as.36 (ader and Khan 28). Ths parameer value mples ha degree of hab perssene n onsumpon s que low as ompared wh advaned eonomes; see for nsane ubk and Shorfede (25). The sem-elasy of money demand o neres rae ( ) s aken as -.5 (ader e al. 22). I shows ha money demand s less elas wh respe o nomnal neres rae. The relave wegh n preferenes assgned o real money balanes ( M ) s.25 (Ahmad e al. 22). The parameer value of wage elasy of labour supply ( ) aken as.5. Ths value s onssen wh he esmaes repored by Ahmad e al. (22) and Fagan and Messna (29). The share of ore goods n he onsumpon baske of household ( ) s aken as.75. Ths value s ompued from Paksan s ousehold Inegraed Eonom Survey (IES) 2-. A smlar esmaed value s used by Ban (2b) for Indan ase. Ths shows ha subssene level of onsumpon s hgh n mos of developng eonomes and people spend approxmaely 75% of her budge on ore-onsumpon relaed goods. The res of share s alloaed o ol and energy relaed ems. The elasy of neremporal subsuon beween ore and ol goods onsumpon bundle s fxed a.35. Ths value s onssen wh poseror esmaes gven n An and Kang (29) for he Korean and Medna and Soo (27) for Chlean eonomes. C -28-

30 The share of formal seor goods n he ore onsumpon baske ( C ) s se o be.55. The esmae s loser o value gven n Ahmad e al. (22) and Khan and Khan (2). The elasy of subsuon beween formal and nformal goods onsumpon bundle ( C ) s aken as.7. Ths hgh value of subsuon elasy shows sgnfan share of nformal goods onsumpon n he ore onsumpon bundle. The share of home goods n he formal onsumpon baske ( C ) s fxed a.65. The orrespondng elasy of subsuon beween home and foregn goods onsumpon bundle ( C ) s aken as.2. These parameer values are onssen wh he poseror esmaes gven n An and Kang (29) and ader and Khan (28). The share of formal labor n aggregae labor supply ( ) s aken as.29. Ths value s onssen wh esmaes used n Choudhr and Malk (22) and Ahmad e al. (22). 8 Ths s due o he fa ha n developng ounres abou 7% of he non-agrulure labor s employed n he nformal seor. The orrespondng elasy of subsuon beween formal and nformal labour supply ( ) s fxed o be 2. and elasy of subsuon beween dfferen labor sklls n he formal seor ( ) s aken as.8. Ahmad e al. (22) has esmaed hese values usng labour fore survey daa from Paksan. The seond aegory of parameers s relaed o aggregae nvesmen and produon sde of he eonomy. The share of home nvesmen n aggregae prvae nvesmen ( I ) s fxed a.52. The orrespondng elasy of subsuon beween home and foregn prvae nvesmen ( I ) s aken as.2. These parameer values are onssen wh Medna and Soo (27). abor share n formal seor produon ( ) s fxed a.54. Ths parameer value s aken from Bukhar and Khan (28). The apal depreaon rae ( ) s aken as.3. I mples apal depreaes annually around 2%. Bukhar and Khan (28) ader and Khan (28) and Ahmad e al. (22) sudes used a smlar esmaes for depreaon rae for Paksan eonomy. For smply he elasy of subsuon beween dfferenaed formal nermedae varees ( ) s fxed a.. Followng Medna and Soo (27) fla ax rae on boh fnal home goods ( ) and fnal mpored goods ( F ) are fxed a.5. The share of nonol faor npus n he produon of nermedae formal seor varees ( ) s fxed.65 and for nermedae nformal seor varees ( ) a.75. The orrespondng elasy of subsuon beween ol and oher faor of npus n formal produon ( ) s aken.85 and for faor of npus n nformal produon ( ) a.95. The hrd aegory of parameers s relaed o pre seng behavor n boh formal and nformal seors. Reen survey sudes on he frequeny of pre hange n emergng marke eonomes sugges ha pres are more flexble as ompared wh he developed ounres (see for nsane Choudhary e al. 2). In Calvo (983) saggered prng sense less degree of skness provde reasonable noon abou frequen pre hanges n developng eonomes. Ths means probably of no hangng pre s que low n a gven quarers. Therefore followng survey esmaes as gven n Choudhary e al. (2) he parameer values of degree of pre skness for formal seor home goods sold domesally ( ) s fxed a.24 and for formal seor home goods sold abroad ( ) s a.64 respevely. On he oher hand he degree of pre skness for formal seor mpored goods ( F ) s aken as.7. Fnally he degree of pre ndexaon o eah aegory s adjused o replae flexble naure of pres. These parameer values pre skness along wh he degree of ndexaon are also onssen wh he poseror esmaes as gven n ader and Khan (28) for Paksan and de-casro e al. (2) for of 8 Ahmad e al. (22) alulae hs parameer value by akng average of raos of number of people employed n he formal seor o oal number of people employed n he non-agrulural seor durng o The labour fore daa used n he alulaon of hese raos s aken from varous ssues of he abor Fore surveys Paksan Bureau of Sass. -29-

31 Brazlan ase. 9 Choudhary e al. (2) survey fndng also sugges us o se degree of pre skness for nformal seor goods ( ) a.2. The degree of pre ndexaon for hese goods ( ) s fxed a.7. The las aegory of sruural parameers s assoaed wh he enral bank reaon funon. We have esmaed hese parameers whh sasfed opmal moneary poly rera n a Ramsey poly sense. We assume opmal moneary poly as a baselne ase. The esmaed opmal parameer values sugges nflaon oeffen ( ) o be fxed a.2 whh s slghly low as ompared wh Taylor (993) suggesons for he S ase. The opmal relave wegh relaed o hanges n oupu growh ( ) s aken a.6 and o exhange rae fluuaons ( rer ) a.5. These esmaed values show ha enral bank n a developng eonomy also pu sgnfan weghs on growh and exhange rae sably objeves along wh nflaon. Fnally he opmal wegh assoaed wh AR() erm of poly rae shows onsderable nera whh s around 63%. These parameer values for he baselne ase are also onssen wh an empral sudy by Ahmed and Malk (2) for Paksan ase. We have also used dfferen parameer values of moneary poly reaons funon o evaluae alernave moneary poly regmes n he onex of developng ounres. The parameer values relaed o sxeen exogenous shoks are repored n Table C2 of Appendx C. We have ompued perssene level and sandard devaon orrespondng o eah shok. For he benhmark developng eonomy we have used daa from Paksan o esmae hese parameers. The resuls show ha exernal shoks are more volale as ompare wh domes one. Also hese shoks sgnfy hgh perssene whh suggess developng eonomes are more prone o shoks propagae manly from he exernal sde of he eonomy. Fnally for model albraons seady sae values of key endogenous varables are gven n Table C3 of Appendx C. These values are alulaed by akng long erm averages o eah varable. For hs purpose he daa s aken from Paksan eonomy. owever esmaes relaed o nformal oupu s aken from Gulzar e al. (2). 5.2 Quanave Assessmen and Empral Fness of he Model In hs seon we ry o assess he quanave performane of he model by drawng omparsons wh quanave feaures of he busness yle sass. The man purpose of hs quanave assessmen s o es empral fness of he model. I examnes wheher a onsrued DSGE model s really apable o replae sandard feaures of busness yles whh preval n he developng eonomes lke Paksan. The sandard RBC/DSGE leraure res o ompare sasal momens of he daa from hose generaed by he model. Therefore followng hs approah we fous on he model s predon wh respe o he volaly of key maroeonom varables relave volaly of hese seleed varables wh respe o formal seor oupu and he onemporaneous orrelaons of hese varables wh eah oher. The resuls are repored n Table C4 C5 and C6 of Appendx C. The Table C4 shows he sandard devaons for formal onsumpon nformal onsumpon formal seor oupu nformal seor oupu agrulure ommody oupu formal seor nflaon nformal seor nflaon real exhange rae aggregae labour aggregae wages domes nvesmen foregn nvesmen ol onsumpon domes neres rae governmen onsumpon and urren aoun. The able also provdes resuls of relave sandard devaons of hese varables wh respe o formal seor oupu. The model mahes he observed volaly n formal seor onsumpon nformal seor onsumpon nflaon n he formal and nformal seor and aggregae oupu n he Paksan whh urns ou o be hgh bu no very dfferen from he volaly n hese wo key varables n oher developng eonomes. 2 I over preds he volaly n few oher endogenous varables lke agrulure ommody oupu domes and foregn nvesmens and ol onsumpon. The preded volaly of he domes neres raes and urren aoun are slghly lower han observed n Paksan bu hgher y 9 These low parameer values shows he less proporon of frms ha do no re-opmze her pres n a gven quarers. Furhermore hese saggered pre oeffens also mply ha he average duraon of pre onras s around one o wo quarers for domes frms. Ths duraon s alulaed as: /(-). 2 See for nsane Aguar and Gopnah (27) for a omparson wh oher emergng ounres. -3-

32 han observed n he emergng ounres and hese are abou equal o he mean volaly for he panel of all seleed ounres as aken n Aguar and Gopnah (27). The same s rue for volaly of he res of he varables; he model s preded value beng hgher han Paksan s and lower han n he oher developng ounres bu approxmaely equal o he average volaly for he omplee se of ounres. In erms of he relave sandard devaons he model preds hgher volaly of formal and nformal onsumpon relave o GDP. Ths s a unque sylzed busness yle fa of emergng ounes and he model s farly apable o replae hs fa. owever preds a hgher volaly of domes and foregn nvesmen relave o formal seor oupu han observed n Paksan and oher emergng eonomes. As far as he relave volaly n res of he seleed endogenous varables wh oupu s onerned hs model underesmaes he resuls as ompared o he daa. The Table C5 presens he onemporaneous orrelaon and Table C6 shows auo-orrelaons of all hese sxeen varables. Among hese resuls onemporaneous orrelaons of all endogenous varables wh respe o aggregae formal seor oupu have prme mporane due o heoreal momen mahng onerns of he model. Auo-orrelaons resuls ndae non-saonary behavor of seleed varables a level. Our DSGE model does well n mahng hese orrelaons produng resuls wh orre sgns ha le beween he observed values for Paksan and oher emergng eonomes. Broadly speakng he model does que well quanavely produng momens ha are roughly onssen wh emprally observed ounerpars n developng eonomes n general and Paksan eonomy n parular. 5.3 Impulse Responses The mpulse response funons ompue dynam responses of model varables o he fundamenal eonom dsurbanes. These are ploed agans he number of quarers ha have elapsed sne he shok ourred. 2 We have ompued mpulse-response of he key endogenous varables o he sxeen exogenous shoks hng he domes eonomy under fve dfferen moneary poly regmes. These alernave regmes are represened by onvenonal Taylor (993) ype neres rae rules wh varous poly assumpons. 22 These assumpons vary wh respe o he dfferen responsveness of he enral bank o s varous key objeves lke nflaon eonom growh neres rae smoohng and exhange rae sably. owever among all hese poly spefaons pre sably s aken as a prmary objeve of he enral bank. The frs spefaon named as baselne poly whh follows opmal Ramsey poly rule defned n erms of welfare opmzaon rera. We have alulaed opmal reaon parameers usng hs spefaon. The values are as follows:.63.2 y.6 and rer.5. These relave weghs assoaed wh he baselne rule are haraerzed by a moderae reaon o nflaon a sronger response o hanges n eonom growh a sgnfan degree of neres rae smoohng and a margnal reaon o exhange rae movemens. The seond spefaon assumes onsderable nera n he poly rae and enral bank n hs ase only respond o nflaon. owever he responsveness s less aggressve. The poly reaon parameers used n hs spefaon are:.9. y and. The hrd spefaon s smlar o seond one. owever n hs ase response of enral bank o rer nflaon s more aggressve. The poly reaon parameers used n hs spefaon are:.9.65 and. The forh spefaon assumes onsderable nera n he poly rae and y rer 2 The mpulse responses o a one un nrease n he varous sruural shoks are alulaed usng Mone- Carlo smulaons. These smulaons are performed usng MATAB verson 2b. 22 The fundamenal reason o onsder alernave moneary poly regmes based on Taylor ype rule s due o he fa ha moneary poly n mos of he emergng ounres swhed from he radonal moneary aggregaon rule o he neres rae rule n he lae 99s (Alba e al. 22). The urren moneary poly prae n suh eonomes o aheve he objeve of pre sably no longer nvolve seng quanave arge for any nomnal varable for example broad money growh or exhange rae as an nermedae arge (ussan 22). -3-

33 enral bank n hs ase respond o boh nflaon and oupu. owever he oupu response s less aggressve. The poly reaon parameers used n hs spefaon are:.9.2 y.53 and rer. as spefaon of moneary poly rule s smlar o forh wh a dfferene s ha here response o oupu s more aggressve. The poly reaon parameers used n hs spefaon are: and. Based on hese alernave moneary poly spefaons we y rer have smulaed mpulse responses and resuls are dsplayed n Fgures C o- C6 of Appendx C. We sar by llusrang he dynam effes of an nernaonal ol pre shok on a number of endogenous varables. Fgure C of Appendx C represens he mpulse responses o a un posve nnovaon n nernaonal ol pre under he fve alernave moneary poly regmes. Ths shok has a frs round mpa on margnal oss of formal and nformal seor produon. Therefore nflaon rses n boh hese seors. Due o nrease n nflaon oupu and onsumpon fall n eah seor respevely and hen onverges o s seady sae level. On he household sde ol pre nrease reaes a negave nome effe ha redues domes onsumpon. As a resul he demand for dfferen ypes of goods n he onsumpon baske falls. There s also a subsuon effe ha ends o nrease he demand for boh formal and nformal goods. owever sne he degree of subsuon beween ol and he oher ypes of goods s low hs effe does no ounera he negave nome effe on he demand for ore goods. Moreover hs shok also pushes up he os of formal and nformal seor frms produng hese ypes of goods and her pres relave o he pre of foregn goods nreases. Ths shok also has a negave mpa on domes and foregn nvesmen. Exhange rae depreaes n hs ase and hs shok fores a furher moneary ghenng n he poly neres rae. 23 We have also noe ha boh moneary poly spefaons generae a smlar knd of responses unlke he spefaon wh more aggressve reaon o oupu n whh more adverse onsequenes n all endogenous varables are beng observed. Nex we have ompued dynam mpulse responses assoaed o un negave shok n domes and foregn nvesmen. On average he responsveness of endogenous varables o hese shoks under all poly regmes s smlar. owever n erms of magnude he negave shok o foregn nvesmen has more adverse onsequenes as ompared wh domes one. The resuls are dsplayed n Fgure C2 and C3 of Appendx C. Followng hese shoks oupu drops and nflaon rse up boh n formal and nformal seors. Exhange rae depreaes as nvesmen goods are relavely more mpor nensve han oher fnal goods. The moneary poly response under mos of regme spefaons o hese shoks lead o a surge n he neres rae. Smlar knds of resuls are assoaed wh negave adjusmen os shok whh s dsplayed n Fgure C4 of Appendx C. These resuls sugges mplaons assoaed wh he sudden sops n foregn apal nflows and her lkely adverse onsequenes on he key endogenous varables. Domes eonomy ends up wh sagflaon suaon n he form of hgh nflaon and a reduon n oupu. Fgure C5 of Appendx C show mpulse responses o a negave foregn demand shok. Due o hs shok all domes endogenous varables behave aordng o he heory. A reduon n he foregn demand leads o an nrease n domes formal seor nflaon a ghenng of moneary poly and a fall n oupu onsumpon and employmen. On he oher hand a negave ommody pre shok generaes an oupu onraon a reduon n employmen and a surge n nflaon. Ths las effe s explaned by he urreny depreaon whh nreases mpored nflaon and makes apal goods expensve. Ths reaes a burden on margnal oss and fores a reduon n real wages. Fnally urren aoun faes def poson and neres rae rses due o hs shok. These resuls are dsplayed n Fgure C6 of Appendx C. The nex fgure plos he mpulse responses o a posve mpor pre shok. The mpa of hs shok on he model endogenous varables s que smlar wh nernaonal ol pre shok. In response o hs shok domes formal seor nflaon nreases as hgher mpor pres pushng up he os of produon auses as a surge n domes nflaon. Aggregae onsumpon dereases due o a foregn pre surge relave o domes pres. The eonom nerpreaon of hs reduon s ha domes agens subsue ou of foregn produed goods no home produed goods n response o posve 23 These resuls are smlar wh a reen empral sudy by Khan and Ahmed (2) for he ase of Paksan. -32-

34 mpor pre shok whh auses expendure swhng effe and hene leads o a delne n he aggregae onsumpon. Ths shok also leads o exhange rae depreaon and a reduon n oupu and all knd of nvesmens. The resuls assoaed wh mpor pre shok are dsplayed n Fgure C7 of Appendx C. Nex we have observed response of endogenous varables due o a posve foregn neres rae shok. Ths shok affes negavely nvesmen desons and nreases onsumpon of foregn seor goods and leads o a reduon n aggregae oupu and n employmen. Ths shok also generaes a real appreaon of he urreny and a reduon n foregn nvesmen. Opmal moneary poly response o hs shok suggess an nrease n he poly rae o boos up foregn nvesmen. The resuls of hs shok are dsplayed n Fgure C8 of Appendx C. The nex fgure plos he mpulse responses o a posve foregn nflaon shok. Due o hs shok onsumpon of foregn seor goods delne whereas nformal seor goods onsumpon rses up. Ths s manly due o nrease n he pre of mpored ems whh fores a subsuon affe n he formal and nformal onsumpon goods. Ths shok helps he domes eonomy by nreasng domes and foregn nvesmen. Moneary poly reaon s loose o hs shok by dereasng poly neres rae. The resuls are gven n Fgure C9 of Appendx C. The mpulse responses assoaed wh negave ransory and permanen produvy shoks and negave agrulure ommody produon shok are dsplayed respevely n Fgures C C and C2 of Appendx C. The produvy shoks have a negave mpa on formal and nformal seor oupu. These shoks also mply an mmedae surge n nflaon as hey nrease margnal oss of produon. owever n response o he permanen produvy shok nflaon rses sgnfanly above s seady sae afer some perods. The moneary auhory ghs s poly rae n response o he surge n nflaon. For boh shoks employmen nally rses beause he reduon of aggregae demand assoaed wh he moneary onraon.. The negave ransory ehnology shok ends o depreae he real exhange rae however he negave permanen produvy shok leads o a real appreaon of he urreny explaned by he moneary poly ghenng ha follows some perods afer he shok o urb nflaon. Smlar resuls have been observed for he ase of agrulure ommody produon shok. The preferene shok on he oher hand nreases formal and nformal seor goods onsumpon. Due o rse n onsumpon demand fores nflaon o rse up. The opmal moneary poly response o hs shok suggess a furher ghenng of poly neres raes. We have also observed mpulse responses o posve domes labour supply shok. Due o hs shok oupu nally rses and hen afer one quarer delnes from s seady sae. The laer derease n oupu shows ha agen's subsuon beween workng and lesure domnaes he lower os of produon ha arses from he nrease n labour supply. The resuls assoaed wh hese shoks are dsplayed respevely n Fgures C3 and C4 of Appendx C. Nex fgure shows he mpulse response o a posve neres rae shok. Ths shok an be hough of a onraonary moneary poly shok. Followng an unanpaed surge n he poly neres rae a delne n nflaon and oupu s observed boh n formal and nformal seors. On he oher hand exhange rae depreaes due o hs shok before reurnng o s equlbrum level. Ths shok also redues domes and foregn nvesmen by nreasng os of busness and here s a fall n he aggregae employmen. We have also noe ha boh moneary poly spefaons generae a smlar knd of responses unlke he spefaon wh less aggressve reaon o nflaon n whh more onraon n mos of endogenous varables are beng observed. These resuls are dsplayed n Fgure C5 of Appendx C. The las fgure shows mpulse responses o posve shok o governmen spendng. Ths shok fores domes poly neres rae o rse whh reaes a burden on formal seor frms o nves n prvae apal. I resuls n a rowdng-ou effe on domes vs-à-vs foregn nvesmens. Ths shok also lowers aggregae wage and nrease employmen a a os of nflaon. Ths shok produes urren aoun def and exhange rae depreaes before reurnng o s seady sae level. We have also observed ha baselne moneary poly yelds more opmal responses as ompued wh oher alernave poly regmes n erms of onraon n key endogenous varables. These resuls are dsplayed n Fgure C6 of Appendx C. -33-

35 5.4 Varane Deomposons In he prevous subseon we arefully analyzed and undersand he ransmsson mehansms of exogenous shoks and orrespondng responsveness of key endogenous varables o eah shok. We also observed ha hese shoks propagae from domes and exernal soures. Now queson arses how muh do hese shoks onrbue boh as a group and ndvdually o eonom fluuaons n a represenave emergng marke eonomy? I depends no jus on he magnude of he response when a shok of a gven sze ours bu also how ofen and on average wha sze of shoks h he domes eonomy. Ths problem an be akled by onsderng a famous empral ehnque known as varane deomposons whh ompue he perenage of he foreas error varanes a varous foreas horzons ha are arbuable o eah of he ndvdual shoks or a group of shoks. We fous here on a medum erm horzon whh defned hree years of me nerval. The resuls are repored n Table C7 of Appendx C. We have observed ha exernal shoks explan around 5% of he fluuaons n onsumpon of formal seor goods. Whereas onsumpon of nformal seor goods s manly explaned by domes shoks whh unover 73% of s fluuaons. Smlar resuls an be observed wh respe o domes formal and nformal seor oupu. Exernal shok mosely explan foreas error n formal seor oupu whh s around 52.3% whereas fluuaon n nformal seor oupu s manly explaned by domes shoks. In onras wh hese resuls however busness yle fluuaons n boh formal and nformal seor nflaon are manly deermned by domes shoks whh over around 7% of oal varaons. Fluuaons n real exhange rae and ol onsumpon are manly explaned by exernal shoks whereas he res of endogenous varables are h by shoks propogaed from domes soures. Fnally we noe ha domes shoks are relavely more mporan n explanng movemens n varables over longer horzons whereas shor run fluuaons are manly deermned from exernal shoks. 5.5 Performane of Alernave Moneary Poly Rules under earnng Ths seon evaluaes he performae of baselne opmal moneary poly rule wh four alernave rules norporang dfferen responses o nflaon hanges n eonom growh neres rae smoohng and exhange rae fluuaons. We evaluae performae of hese rules wh wo approahes: frs onvenonal welfare loss reron based on quadra approxmaon of household uly and seondly hrough moneary poly learnng n erms of analyzng ondons of expeaonal sably (E-sably) and In-deermnay. 24 Table C8 of Appendx C repors he welfare losses assoaed wh he fve moneary poly rules analyzed n he prevous seon: baselne poly less aggressve an-nflaon poly more aggressve an-nflaon poly less aggressve reaon o oupu and more aggressve reaon o oupu. There are fve panels n hs able. The frs panel repors welfare losses n he ase of our baselne parameerzaon whle he remanng four panels dsplay he effes of alernave spefaons. Correspond o eah panel we have repored volaly assoaed wh eah endogenous varables. Along wh volaly resuls we have also repored welfare loss resuls assoaed o formal and nformal seors. Among hese albraon resuls baselne poly ou performs all oher regme spefaons. I produes less volaly n endogenous varables and yeld mnmum welfare loss boh n formal and nformal seors. Fnally we have also observed ha more-aggressve an-nflaon poly yeld seond bes resuls. The mpled welfare losses n hs ase are quanavely small as ompared wh all oher poly regmes. Nex we follow Bullard and Mra (22 27) o assess opmal moneary poly hrough learnng n erms of E-sably and In-deermnay ondons. Sne s hard o derve lear analyal resuls due o omplex open eonomy DSGE model wh formal and nformal seors we presen a numeral smulaon on a albraed verson of our eonomy and hek he deermnay area. We onsder four alernave ases: ) less nera n moneary poly and no reaon o exhange rae ) more nera n moneary poly bu no reaon o exhange rae ) less nera n moneary poly wh 24 A bref dsusson on moneary poly learnng s gven n Appendx B. -34-

36 reaon o exhange rae and v) more nera n moneary poly wh reaon o exhange rae. For eah ase along wh all possble values of par ( ) our numeral roune 25 heks he Egen-values of y omplee model soluon o deermne wheher all he egenvalues have real par less han uny. Regons where he soluon s deermnae (and hus E-sable) are shown n dark green olor forma. Regons where a leas one egenvalue have a real par greaer han uny are whe.e. he soluon s ndeermnae. The resulng graphs are dsplayed n Fgure C7 o C2 of Appendx C. From hese resuls we have noed several poly mplaons. The frs mplaon s assoaed wh Taylor Prnple. Ths means ha eah ase mus ensure ha model E-sably and equlbrum deermnay are possble only when enral bank ses relave wegh o nflaon whh s greaer or equal o one. The lkelhood of n-deermnay s maxmum n he frs ase. Ths means a poly wh less nera n poly rae along wh zero-reaon o exhange rae s no opmal. The seond ase also generaes E-nsably area even n a ase where enral bank follows Taylor prnple. Thrd and forh poly ombnaons produe relavely more desrable resuls. These ases ensure more lkelhood of deermnay and E-sably. owever resuls of frs moneary poly evaluaon rera based on soey welfare loss mee wh he hrd spefaon of moneary poly learnng n erms of E-sably and deermnay. I ndaes ha enral bank n emergng marke eonomy mus follow Taylor Prnple and pu some wh on exhange rae fluuaons even here s less nera n he poly neres rae. 6. CONCDING REMARKS In hs paper we develop a wo-blo open eonomy DSGE model nerang wh he res of he world. Alongsde sandard feaures of emergng eonomes suh as a ombnaon of produer and loal urreny prng for exporers foregn apal nflow n erms of foregn dre nvesmen and ol mpors our model also norporaes nformal labor and produon seors. Ths nensfes he exposure of a developng eonomy o nernal and exernal shoks n a manner onssen wh he sylzed fas of busness yle fluuaons. More spefally we have onsdered nne domes and seven exernal shoks. In he presene of hese shoks our model reasonably apures he lkely responses of key endogenous varables whh are onssen wh he exsng empral leraure avalable for developng ounres. We also evaluae he performane of he model by oher onvenonal measures n erms of heoreal momens mahng lke sandard devaons onemporaneous orrelaons auoorrelaons e. Broadly speakng our model omprehensvely mahes paerns of busness yle sass onssen wh he empral fas from emergng marke eonomes. We hen fous on opmal moneary poly analyss by evaluang alernave neres rae rules and albrang he model usng daa from Paksan eonomy as benhmark emergng eonomy ase. The learnng and deermnay analyss sugges moneary auhory n developng eonomes o follow Taylor prnple and o pu some wegh on exhange rae fluuaons even f here s relavely less nera n he seng of poly neres rae. Fnally for he fuure researh hs model an be exended by norporang bankng and nonbankng fnanal seors o undersand dynams assoaed wh fsal borrowng from he bankng sysem and s lkely onsequenes on moneary expanson and nflaon. Ths helps o explan fsal domnane ssue whh s also an mporan feaure of developng eonomes n large. 25 These numeral rounes are mplemened by usng Global Sensvy Analyss oolk avalable wh Dynare

37 REFERENCES Adolfson M. aséen S. nde J. and Vllan M. (28). Evaluang an esmaed new Keynesan small open eonomy model Journal of Eonom Dynams and Conrol 32: Adolfson M. aséen S. nde J. and Vllan M. (27a). RAMSES: a new general equlbrum model for moneary poly analyss Eonom Revew Vol. 2 Rsksbank Adolfson M. aséen S. nde J. and Vllan M. (27b). Bayesan esmaon of an open eonomy DSGE model wh nomplee pass-hrough Journal of Inernaonal Eonoms 72: 48-5 Agénor P. and Monel P. J. (2). Developmen Maroeonoms. 3rd Edon Prneon nversy Press Agénor P. MDermo C. J. and Prasad E. S. (2). Maroeonom Fluuaons n Developng Counres: Some Sylzed Fas World Bank Eonom Revew World Bank Group 4: Aguar M. and Gopnah G. (27). Emergng Marke Busness Cyles: The Cyle Is he Trend Journal of Polal Eonomy nversy of Chago Press 5: 69 2 Ahmad S. Ahmed W. Pasha F. Khan S. and Rehman M. (22). Paksan Eonomy DSGE Model wh nformaly SBP Workng Paper No. 47 Sae Bank of Paksan Ahmed A. M. and Malk W. S. (2). The Eonoms of Inflaon Issues n he Desgn of Moneary Poly Rule and Moneary Poly Reaon Funon n Paksan ahore Journal of Eonoms 6: Ahmed S. Ara I. and yder K. (26). ow Exernal Shoks and Exhange Rae Depreaons Affe Paksan? Implaons for Choe of an Exhange Rae Regme SBP Researh Bullen 2: 6 88 Ahmed W. ader A. and Iqbal J. (22). Esmaon of Dsoun Faor and Coeffen of Relave Rsk Averson n seleed ounres SBP Workng Paper No. 53 Sae Bank of Paksan Alba J. D. Cha W. and Park D. (22). A Welfare Evaluaon of Eas Asan Moneary Poly Regmes under Foregn Oupu Shok ADB Eonoms Workng Paper Seres No. 299 Asan Developmen Bank. Alug S. (989). Tme-o-Buld and Aggregae Fluuaons: Some New Evdene Inernaonal Eonom Revew 3: Aruoba S. (2). Informal Seor Governmen Poles and Insuons Mmeo nversy of Maryland An S. and Kang. (2). Ol Shoks n a DSGE Model for he Korean Eonomy NBER Chapers n: Commody Pres and Markes Eas Asa Semnar on Eonoms Volume 2 pages Naonal Bureau of Eonom Researh In Anunes A. and Cavalan T. (27). Sar up Coss med Enforemen and he dden Eonomy European Eonom Revew 5: Ban N. Gabrel V. evne P. and Pearlman J. (2a). A Floang versus Managed Exhange Rae Regme n a DSGE Model of Inda Shool of Eonoms Dsusson Papers 4 Shool of Eonoms nversy of Surrey -36-

38 Ban N. evne P. Km Y. and o E. (2b). Informal abour and Cred Markes: A Survey IMF Workng Papers /42 Inernaonal Moneary Fund Ban N. evne P. and o E. (2a). The Coss and Benefs of Informaly Shool of Eonoms Dsusson Papers 2 Shool of Eonoms nversy of Surrey Ban N. evne P. o E. and Bo Y. (2b). Moneary and Fsal Poly n he Presene of Informal abour Markes Workng Papers /97 Naonal Insue of Publ Fnane and Poly Inda Ban N. evne P. o E. and Bo Y. (2). Informaly Frons and Moneary Poly Shool of Eonoms Dsusson Papers 7 Shool of Eonoms nversy of Surrey Blanhard O. J. and Kahn C. M. (98). The soluon of lnear dfferene models under raonal expeaons Eonomera 48: 35 3 Blanhard O. J. and Wason M. W. (986). Are Busness Cyles All Alke? In Rober J. Gorden The Ameran Busness Cyle: Connuy and Change 23 8 Naonal Bureau of Eonoms Researh In Bormoov M. (29). Eonom yles: hsoral evdene lassfaon and explaon MPRA workng paper no. 966 Bukhar S. A.. A. S. and Khan S.. (28). Esmang Oupu Gap for Paksan Eonomy: Sruural and Sasal Approahes SBP Researh Bullen 4: 3 6 Bullard J. and Mra K. (22). earnng abou Moneary Poly Rules Journal of Moneary Eonoms 49: 5 29 Bullard J. and Mra K. (27). Deermnay learnably and moneary poly nera Journal of Money Cred and Bankng 39: Calvo G. A. (983). Saggered pre seng n a uly-maxmzng framework Journal of Moneary Eonoms 2: Calvo G. and Renhar C. (2) When apal nflows ome o a sudden sop: onsequenes and poly opons In Kenen P. and Swoboda A. (Eds) Reformng he Inernaonal Moneary and Fnanal Sysem 75 2 Inernaonal Moneary Fund Washngon DC Calvo G. Izquerdo A. and Meja. (24). On he emprs of sudden sops: he relevane of balane-shee effes NBER Workng Paper No. 52 NBER Cambrdge MA Calvo G. Izquerdo A. and Meja. (28). Sysem sudden sops: he relevane of balane-shee effes and fnanal negraon NBER Workng Paper No. 426 NBER Cambrdge MA. Char V. V. Kehoe P. and MGraan E. R. (22). Aounng for he Grea Depresson. Ameran Eonom Revew 92: Char V. V. Kehoe P. and MGraan E. R. (27). Busness Cyle Aounng Eonomera 75: Choudhr E.. and Malk. A. (22). Moneary Poly n Paksan: A Dynam Sohas General Equlbrum Analyss. IGC Workng Paper 2/389 Inernaonal Growh Cener (IGC) ondon Shool of Eonoms and Polal Sene K -37-

39 Choudhary M. A. Naeem S. Faheem A. aneef M. N. and Pasha F. (2). Formal Seor Pre Dsoveres: Resuls from a Developng Counry Shool of Eonoms Dsusson Papers Shool of Eonoms nversy of Surrey Chrsano. and Ehenbaum M. (992). Curren Real-Busness Cyle Theores and Aggregae abor- Marke Fluuaons Ameran Eonom Revew 82: Chrsano. J. Ehenbaum M. and Evans C.. (997). Sky pre and lmed parpaon models of money: A omparson European Eonom Revew 4: Chrsano. J. Ehenbaum M. and Evans C.. (998). Moneary poly shoks: Wha have we learned and o wha end? In Taylor J. B. and M. Woodford (Eds.) andbook of Maroeonoms Amserdam Norh- olland Chrsano. Ehembaum M. and Evans C. (25). Nomnal rgdes and he dynam effes o a shok of moneary poly Journal of Polal Eonomy 3: 45 Clarda R. and Gerler M. (997). ow he Bundesbank ondus moneary poly Memo Bundesbank Clarda R. Gal J. and Gerler M. (998). Moneary poly rules n prae: Some nernaonal evdene European Eonom Revew 42: Clarda R. Gal J. and Gerler M. (999). The sene of moneary poly: A new Keynesan perspeve Journal of Eonom eraure 37: Clarda R. Gal J. and Gerler M. (2). Moneary poly rules and maroeonom sably: Evdene and some heory Quarerly Journal of Eonoms 5: 47 8 Conesa J. C. Daz-Moreno C. and Galdon-Sanhez J. E. (22). Explanng Cross-Counry Dfferenes n Parpaon Raes and Aggregae Fluuaons Journal of Eonom Dynams and Conrol 26: Cooley T. F. (995). Froners of Busness Cyle Researh Prneon: Prneon nversy Press de-casro M. R. Gouvea S. N. Mnella A. dos Sanos R. C. and Souza-Sobrnho N. F. (2). SAMBA: Sohas Analyal Model wh a Bayesan Approah Workng Papers Seres 239 Cenral Bank of Brazl Researh Deparmen Devereux M. B. and Engel C. (22). Exhange rae pass-hrough exhange rae volaly and exhange rae dsonne Journal of Moneary Eonoms Elsever 49: Db A. Gammoud M. and Moran K. (28). Foreasng Canadan me seres wh he New Keynesan model Canadan Journal of Eonoms Canadan Eonoms Assoaon 4: Evans G. and onkapohja S. (2). earnng and Expeaons n Maroeonoms Prneon nversy Press Prneon Fagan G. and Messna J. (29). Downward Wage Rgdy and Opmal Seady Sae Inflaon ECB Workng Paper Seres Workng Paper No: 48 European Cenral Bank. Framer R. E. A. (992). Nomnal Pre Skness as Raonal Expeaon Equlbrum Journal of Eonom Dynams and Conrol 6:

40 Frsh R. (933). Propagaon Problems and mpulse problems n dynam eonoms. In Eonoms Essays n onor of Gusav Cassel ondon: George Allen Gabrel V. evne P. Pearlman J. and Yang B. (2). An Esmaed DSGE Model of he Indan Eonomy Shool of Eonoms Dsusson Papers 2 Shool of Eonoms nversy of Surrey Gal J. (28). Moneary Poly Inflaon and he Busness Cyle: An nroduon o he New Keynesan Framework Prneon nversy Press Gal J. and Gerler M. (999). Inflaon dynams: A sruural eonomer analyss Journal of Moneary Eonoms 44: Gal J. and Gerler M. (27). Maroeonom modelng for moneary poly evaluaon Journal of Eonom Perspeves 2 Fall Issue Gal J. and Monaell T. (25). Moneary Poly and Exhange Rae Volaly n a Small Open Eonomy Revew of Eonom Sudes 72: Goodfrend M. (27). ow he world aheved onsensus on moneary poly Journal of Eonom Perspeves 2 Fall Issue Goodfrend M. and Kng R. (997). The new neolassal synhess and he role of moneary poly NBER Maroeonoms Annual Vol Gulzar A. Junad N. and ader A. (2). Wha s dden n he dden Eonomy of Paksan? Sze Causes Issues and Implaons The Paksan Developmen Revew 49: ader A. yder K. and Jan A. (22). On he (IR) Relevane of Moneary Aggregae Targeng n Paksan: An Ele Vew npublshed Draf Sae Bank of Paksan ader A. and Khan S.. (28). A Small Open Eonomy DSGE Model for Paksan The Paksan Developmen Revew 47: ussan F. (22). Moneary Poly Framework n Paksan: Evaluaon and Experenes Counry Paper SAARC Fnane Conferene Naonal Insue of Bankng and Fnane (NIBAF) Islamabad. Jusnano A. and Preson B. (24). Small open eonomy DSGE models: spefaon esmaon and model f Manusrp Columba nversy Jusnano A. and Preson B. (25). Can sruural small open eonomy models aoun for he nfluene of foregn shoks Manusrp Columba nversy Khan M. A. and Ahmed A. (2). Maroeonom Effes of Global Food and Ol pre Shoks o he Paksan Eonomy: A Sruural Veor Auoregressve (SVAR) Analyss. Paper presened n 27h PSDE onferene Paksan Insue of Developmen Eonoms Islamabad Paksan. Khan S. A. and Khan S. (2). Opmal Taxaon Inflaon and he Formal and Informal Seors Sae Bank of Paksan Workng Paper No: 4 Klen P. (2). sng he generalzed Shur form o solve a mulvarae lnear raonal expeaons model Journal of Eonom Dynams and Conrol 24:

41 Kolasa M. (28). Sruural heerogeney or asymmer shoks? Poland and he euro area hrough he lens of a wo-ounry DSGE model Naonal Bank of Poland Workng Paper No. 49 Kollmann R. (2). The exhange rae n a dynam-opmzng busness yle model wh nomnal rgdes: a quanave nvesgaon Journal of Inernaonal Eonoms Elsever 55: Koreshkova T. (26). A Quanave Analyss of In.aon as a Tax on he nderground Eonomy Journal of Moneary Eonomy Kremer J. Govann. Von-Thadden. and Werner T. (26). Dynam Sohas General Equlbrum Models as a Tool for Poly Analyss CESfo Eonom Sudes 52: Kydland F. E. and Preso E. C. (982). Tme o buld and aggregae fluuaons Eonomera 5: Kydland F. E. and Preso E. C. (996). The ompuaonal expermen: an eonomer ool Journal of Eonom Perspeves Wner Issue. u P. (26). A Small New Keynesan Model of he New Zealand eonomy Reserve Bank of New Zealand Dsusson Paper Seres No. 3/6 ubk T. and Shorfhede F. (25). A Bayesan look a new open eonomy maroeonoms. In: Gerler M. Rogoff K. (Eds.) NBER Maroeonoms Annual uas J. R. (976). Eonomer poly evaluaon: a rque n K. Brunner and A Melzer The Phllps urve and labor markes Norh olland uas J. R. (977). ndersandng busness yles. In Sablzaon of he domes and nernaonal eonomy Carnege-Roheser Conferene Seres on Publ Poly. Amserdam: Norh-olland. uas J. R. (987). Models of Busness Cyles Blakwell Publshers uas J. R. and Sargen T. J. (979). Afer Keynesan Maroeonoms Federal Reserve Bank of Mnneapols Quarerly Revew 3: 6 Malk W. S. and Ahmed A. M. (2). Taylor Rule and he Maroeonom Performane n Paksan The Paksan Developmen Revew 49: Mankw G. N. (985). Small menu oss and large busness yles: A maroeonom model of monopoly Quarerly Journal of Eonoms : Mankw G. N. (989). Real busness yle: A new Keynesan perspeve Journal of Eonom Perspeves 3: 79 9 Mankw G. N. (99). A quk refresher ourse n maroeonoms Journal of Eonom eraure 28: Mankw G. N. and Romer D. (99). New Keynesan Eonoms MIT Press Boson Mankw G. N. (26). The maroeonoms as sens and engneer Journal of Eonom Perspeves 2: 29-46l -4-

42 MCallum B. (983). On Non-unqueness n near Raonal Expeaons Models: An aemp a perspeve Journal of Moneary Eonoms : MCallum B. T. (988). Robusness Properes of a Rule for Moneary Poly Carnege-Roheser Seres on Publ Poly Norh-olland Amserdam 29: Medna J. P. and Soo C. (25). Ol Shoks and Moneary Poly n an Esmaed DSGE Model for a Small Open Eonomy Workng Papers Cenral Bank of Chle 353 Cenral Bank of Chle Medna J. P. and Soo C. (26). Model for Analyss and Smulaons: A Small Open Eonomy DSGE for Chle Conferene Paper Cenral Bank of Chle Medna J. and Soo C. (27). The Chlean busness yle hrough he lens of a sohas general equlbrum model Cenral Bank of Chle Workng Papers No. 457 Monaell T. (25). Moneary Poly n a ow Pass-hrough Envronmen Journal of Money Cred and Bankng 37: Neumeyer P. A. and Perr F. (25). Busness yles n emergng eonomes: he role of neres raes Journal of Moneary Eonoms 52: Ngalawa. and Veg N. (2). Ineraon of Formal and Informal Fnanal Markes n Quas-Emergng Marke Eonomes. Mmeo presened a Dynare Conferene 2. Obsfeld M. and K. Rogoff (22). "New dreons for sohas open eonomy models" Journal of Inernaonal Eonoms Rebelo S. 25. Real busness yle models: Pas presen and fuure. NBER Workng Paper 4. Romer C. and Romer D. (997). Redung nflaon NBER and nversy of Chago Press Romer D. (993). The New Keynesan Synhess Journal of Eonom Perspeves Ameran Eonom Assoaon 7: 5 22 Romer D. (2). Advaned Maroeonoms. Forh Edon MGraw-ll New York Sargen T. J. and Wallae N. (975). Raonal expeaons he opmal moneary nsrumen and he opmal money supply rule Journal of Polal Eonomy 83: Shmd-Grohé S. and rbe M. (23). Closng small open eonomy models Journal of Inernaonal Eonoms 6: Shneder F. Büehn A. and Monenegro C. E. (2). Shadow Eonomes all over he World: New esmaes for 62 Counres from 999 o 27 Poly Researh Workng Paper No World Bank Sms C. (996). Maroeonoms and Mehodology Journal of Eonom Perspeves : 5 2 Sms C. (22). Solvng near Raonal Expeaons Models Compuaonal Eonoms 2: 2 Smes F. and Wouers R. (23). Moneary Poly n an Esmaed Sohas Dynam General Equlbrum Model of he Euro Area Journal of he European Eonom Assoaon :

43 Smes F. andwouers R. (25). Comparng Shoks and Frons n S and Euro Area Busness Cyles: A Bayesan DSGE Approah Journal of Appled Eonomers 2: 6 83 Smes F. and Wouers R. (27). Shoks and Frons n S Busness Cyles: A Bayesan DSGE Approah Ameran Eonom Revew Ameran Eonom Assoaon 97: Summers.. (986). Some skepal observaons on real busness yle heory Quarerly Revew Federal Reserve Bank of Mnneapols Fall Issue Taylor J. B. (98). Aggregae dynams and saggered onras Journal of Polal Eonomy 88: l 23 Taylor J. (993). Dsreon versus Poly Rules n Prae Carnege-Roheser Seres on Publ Poly Norh-olland Amserdam 39: Taylor J. B. (998). Saggered pre and wage seng n maroeonoms. In Taylor J. B. and M. Woodford (Eds.) andbook of Maroeonoms Amserdam Norh-olland Taylor J. B. (999). Moneary poly rules Chago NBER and nversy of Chago Press Tnbergen J. (95). es aspes néerlandas du problème de l'équlbre nernaonal en longue pérode (raduon) Revue Éonomque Programme Naonal Persée 2: Tovar E. C. (25). The mehans of devaluaons and he oupu response n a DSGE model: how relevan s he balane shee effe? Bank for Inernaonal Selemens BIS Workng Papers No. 92 Tovar E. C. (28). DSGE models and enral Banks Bank for Inernaonal Selemens BIS Workng Paper No. 258 hlg. (999). A Toolk for Analyzng Nonlnear Dynam Sohas Models Easly In Ramon Marmom and Adran So (Eds) Compuaonal Mehods for he Sudy of Dynam Eonomes Oxford nversy Press Walsh C. E. (2). Moneary Theory and Poly 3 rd Edon MIT Press. Woodford M. (24). Ineres and Pres: Foundaons of a Theory of Moneary Poly Prneon nversy Press Zenou Y. (28). Job Searh and Mobly n Developng Counres: Theory and Poly Implaons Journal of Developmen Eonoms

44 APPENDEX-A: og-nearzaon and anonal represenaon of he model Ths seon proeeds by a model soluon mehodology wh he log-lnearzaon and anonal represenaon of he model along wh s foregn seor ounerpar. In order o solve he model we frs sae he frs order nonlnear dynam sysem ha haraerzes he ompeve equlbrum. In order o alulae he seady sae we ransform he sysem equaons no her deermns seady sae represenaon and solve usng numeral mehods. Then we loglnearze around he deermns seady sae where x = ln( x ) ln( x). A hs sage he sysem s expressed n erms of relave devaons from he seady sae. Afer solvng he model usng he mehod of Klen (2) 26 we oban mares M and whh generae he dynam soluon by erang on he followng wo equaons: Y = X X = MX R Where Y s a veor omposed by onrol o-sae and flow varables X s a veor of endogenous and exogenous saes haraerzes he poly funon and M he sae ranson marx. s an nnovaon veor and R s a marx omposed of zeros ones or a parameer nsead of a one. Ths marx deermnes whh varables are h by he shok and n wha magnude. Gven a se of values of he parameers of he model hs sae spae represenaon wll help us o ompue he relevan sass of he model suh as he sperum of he daa he lkelhood funon among ohers. og-lnearzed Equlbrum Relaons The small open eonomy model onsss of he followng log-lnearzed equaons for endogenous varables and equaons for he exogenous proesses expressed n erms of AR() proesses. ousehold's aggregae onsumpon: h h h = E ( ) ( ) E ( C ) E[ C E ( C )] h h h h h h E[ TD E ( TD )] E[ T E ( T )] h h ousehold's real demand for money: h h m = h h h Aggregae labour supply: (S.) (S.2) 26Any oher mehod an also be used o solve he log-lnear approxmaon o he raonal expeaons soluon e.g. Sms (22). -43-

45 h w = h h (S.3) Supply of Doumened and ndoumened labour: D = wd w = w w Compose wage ndex: w = ( ) wd w w w w Where wd = w D Z (S.4) (S.5) (S.6) (S.7) w = p p (S.8) novered neres pary ondon: Aggregae onsumpon bundles: = b ( ) A E e (S.9) = p (S.) Z C Z = p (S.) O C O = p ( ) p (S.2) C Z C O Core onsumpon bundles: = p (S.3) D Z C D = p (S.4) Z C p = p ( ) p (S.5) Z C D C Consumpon bundles of Doumened goods: Equaon of moon of apal sok: = p (S.6) D C = p (S.7) F D C F p = p ( ) p (S.8) D C C F -44-

46 k ( ) nv ( ) k I D = ( D D ) D ( n)( g y) ( n)( g y) (S.9) Invesmen goods bundles of doumened seor: I D I I ( nv ) = nv ( p p ) (S.2) I F F D I F I ( nv ) = nv ( p p ) (S.2) p = p ( ) p (S.22) I I I F Supply and demand for nvesmen goods n doumened seor: Q Q P I I 2 pi = ( q D ) ( ) S( g y) nvd I I r P Q 2 Q 2 S ( g y ) nvd S ( g y ) E ( nvd ) PI PI r I Z q = E ( z ) E ( q ) E ( C ) rq r (S.23) (S.24) FOCs for os mnmzaon and margnal os (Formal Seor): k D DT D = wd z (S.25) o D ( ) k D DT po wd = (S.26) Zk W PO m = ( z k ) ( w ) ( p o ) y (S.27) D D D O D D D O MCY MCY MCY FOCs for os mnmzaon and margnal os (Informal Seor): T = w (S.28) o po w = (S.29) W PO O m = ( w ) ( po o ) y (S.3) MC Y MC Y New-Keynesan Phllps Curve for domes formal-seor goods onsumed a home: = E m p (S.3) where ( )( ) = -45-

47 New-Keynesan Phllps Curve for domesally produed formal-seor expored goods onsumed a abroad: = E m rer p where (S.32) ( )( ) = New-Keynesan Phllps Curve for he mpored goods: F F F = E F F F rer p F F F F (S.33) where F ( )( ) = F F F New-Keynesan Phllps Curve for domes Informal-seor goods onsumed a home: = E m p (S.34) ( )( ) where = The foregn demand for domesally produed goods: = y y p (S.35) aw of one pre of ommody-goods: p rer p (S.36) S = S p rer p (S.37) O = O aw of moon of relave pres: = p p (S.38) Z Z Z C = p p (S.39) C = p p = p (S.4) p (S.4) F F F C = p p (S.42) C = C (S.43) e rer rer Evaluaon of Governmen Consumpon: -46-

48 = b. PG G g = ( y D ) e C b G p DY y D T PDY YD PDY YD ( ) (S.44) G DY D ( p p y ) ( ) BG Where = P Y ( )( g )( n) Y DY and Choe of Fsal Poly nsrumen: g p p y (S.45) DY D = Evaluaon of Fsal ne asse poson: BG PG G B G bg = g PDY YD ( ) PDY YD PDY YD PDY YD ( ) (S.46) BG e C bg pdy y D T PDY Y D BG Where = and P Y ( = b. )( g )( n) Y DY Moneary poly rule: rer r = r y C y D rer m (S.47) Where r = E ( C ) s real rae of neres. The oal aggregae demand for domesally produed goods n he formal-seor s: P Y P C PG = G P I P Y I D y C g p pdy yd I nv y (S.48) P Y P Y P Y P Y P Y Y Y Y Y Y The oal aggregae demand for domesally produed goods n he Informal-seor s: P Y P C y = ( ) C (S.49) P Y P Y Y Y The oal supply for domesally produed goods n he formal-seor s: ( )/ ( )/ / V / O D Y Y y = a A ( ) A o ( )/ / V A Y ( )( kd T ) (S.5) -47-

49 The oal supply for domesally produed goods n he Informal-seor s: ( )/ ( )/ / V / O Y Y y = A ( ) A o (S.5) Real formal-seor GDP: P C PG = G PI ID P EXP EXP PIMP IMP yd g p pdy yd nv exp mp (S.52) PY Y PY Y PY Y PY Y PY Y Real nformal-seor GDP: PC y = (S.53) PY Balane of paymens: ( ) B B B b = ( e C pdy y D b T ) ( ) ( B ) ( ) ( B ) ( )( n)( gdy ) (S.54) PEXP EXP PIMP IMP ( pexp exp pdy y D ) ( pimp mp pdy yd ) P Y P Y DY D DY D Y B G Where B =. P Y DY D Real expors and orrespondng pre-deflaor: PS Y S PS Y S exp = ys PEXP EXP PEXP EXP PS Y S PS Y S pexp = ps p rer PEXP EXP PEXP EXP Real mpors and orrespondng pre-deflaor: PC C PI I D mp = ( C) F ( I) ( nvf ) P IMP P IMP IMP P ( C O O ) C O O o o PIMP IMP CO O O CO O O CO O O O O O O IMP (S.55) (S.56) (S.57) PO ( CO O O ) PO ( CO O O ) pimp = rer po PIMP IMP PIMP IMP s of Exogenous Shoks: F (S.58) = (S.59) Where s veor of 6 exogenous shoks and s a veor of d proesses. -48-

50 APPENDIX B: Deermnay and E-Sably Condons under Moneary Poly earnng Ths seon provdes ehnal deals abou deermnay and expeaonal-sably (E- Sably) ondons under learnng of alernave moneary poly rules. A more general dsusson an be found n Evans and onkapohja (2) and Bullard and Mra (22 27). The fundamenal noon of deermnay enapsulae under a neessary and suffen ondon whh ensure equlbrum o exs. Ths ondon for he unqueness of suh a soluon n a sysem wh no pre-deermned varables s ha orre number of egenvalues le nsde he un rle. Ths dea was nally hghlghed by Blanhard and Kahn (98) and laer exended by MCallum (983) Farmer (992) and Klen (2) for more general ases. ere we elaborae Blahard and Kahn (98) mehod whh s more feasble for model deermnay soluon. B: Condons of Deermnay/oal-Indeermnay: Consder a model gven by he general form: E ( Y ) = E ( Y ) 2 Where Y s a veor of endogenous varables 2 and are mares of oeffens and s a veor of exogenous varables whh s assumed o follow a saonary VAR. If s nverble hen we an wre he sysem as: E ( Y ) = 2E ( Y ) e us assume: and hen he above sysem an re-wren as: 2 E ( Y ) = E ( Y ) sng he noon of Jordan-deomposon we an wre marx as: A A where A s he marx of egenveors of and s he dagonal marx of egenvalues. Sne veor Y may onan bakward and forward lookng varables so we an easly make a paron of Y no wo sub veors suh ha YB s a veor of bakward lookng varables and YF s a veor of forward lookng varables. Therefore we an wre as: YB Y YF nder hese sengs we an express he whole sysem no s deomposon form as: YB YB A A. E ( YF ) YF A A A2 A22 2 If we pre-mulply boh sdes by A hen we ge he followng resul as: B B. E ( F ) 2 F 2 Thus we an easly separae eah equaon as: KB = KB E ( KF ) = 2KF 2 Based upon above deomposed sysem no wo separae equaons Blahard and Kahn (98) provde general deermnay ondons as: -49-

51 Condon (a): f dag( ) and dag( 2) boh ondon rue hen he sysem has a unque soluon (nque Equlbra) Condon (b): f dag( ) holds bu dag( 2) does no hold hen he sysem has many soluons (Mulple Equlbra) Condon (): f dag( 2) holds bu dag( ) does no hold hen he sysem has no soluon. (In-deermnay) These jon deermnay ondons gude us ha whle boh egenvalues of marx A an be shown o be real and posve he larges s always greaer han one. As a resul here exss a onnuum of soluons n a neghborhood of ( ) ha sasfy he equlbrum ondons (loal ndeermnay) and one anno rule ou he possbly of equlbra dsplayng fluuaons drven by self-fulfllng revsons n expeaons. 27 Gal and Monal (25) have argued ha hese ondons an help o undersand varous ombnaons of alernave moneary poly rules. Ther resuls shown ha any knd of ndeermnay problem an be avoded and he unqueness of he equlbrum alloaon resored by havng he enral bank follow a rule whh would mply ha he neres rae should respond o nflaon and/or he oupu gap f hese varables o devae from her (zero) arge values. I requres a redble hrea by he enral bank o vary he neres rae suffenly n response o any devaons of hese varables from arge; ye he very exsene of ha hrea makes s effeve applaon unneessary. In a more general ase wh omplex model sruure Blanhard and Kahn (98) ondons gude o aegorze deermnay and ndeermnay regons numerally usng any weghng sheme of generalzed Taylor-ype moneary poly rule. 28 B2: Condons of E-Sably under learnng: Ths seon brefly desrbes learnng framework of alernave moneary poly rules. sng hs framework we also dsuss expeaonal sably (E-sably) ondons as proposed by Evans and onkapohja (2). nder learnng he agens do no have raonal expeaons nsead hey form her expeed values wh adapve learnng rules whh are updaed as daa s produed by he sysem. The fundamenal dea s ha a eah perod prvae agens possess he Pereved aw of Moon (PM) whose form s smlar o he Mnmum-Sae Varable (MSV) soluons. Sne he agens do no know he parameer values of he sysem hey use a knd of reursve leas square updang rule whh s ondonal upon E-sably. Aordng o Evan and onkapohja (2) and Bullard and Mra (22) hs E-sably s a noonal me onep orrespond o sably under real me adapve learnng under general ondons. Aordng o hem under E-sably reursve leas square learnng soluon s loally onvergen o raonal expeaon equlbrum. They have also argued ha under weak assumpons f raonal expeaon equlbrum s no E-sable hen he probably of onvergene of he reursve leas squares soluon o raonal expeaon equlbrum s zero. To explan hs framework we onsder a model of he form: Y A BE ( Y ) CY D 27 Ths s also known as: saonary sunspo fluuaon. 28 Ths s espeally under suh ases where analyal soluon s no possble. -5-

52 Where Y s a veor of endogenous varables A B C and D are mares of oeffens and s a veor of exogenous varables whh s assumed o follow a saonary VAR. Gven hs general form wh C an MSV raonal expeaonal equlbrum akes he followng form: 29 Y a by Where a b and are onformable and are o be alulaed by he mehod of undermned oeffens. In order o defne E-sably we onsder PM of he same form of he MSV as: Y a by Evan and onkapohja (2) and Bullard and Mra (22) analyze dfferen nformaon assumpon abou how agens updae her PM. The frs assumpon reas expeaons as deermned before he urren values of endogenous varables are o be realzed. nder hs assumpon he nex perod expeaon s: E( Y ) a b( a by ) By subsung no orgnal model form we an ompue Aual aw of Moon (AM) as: 2 Y A ( B( I b)) a ( Bb C) Y ( B( b ) D) To analyze he E-sably ondons we have o hek he sably of he mappng T from he PM o AM: 2 T( a b ) ( A ( B( I b)) a Bb C B( b ) D) sng hs mappng we an easly defne prnple of E-sably whh omes from analyzng he followng marx of dfferenal equaon: d T ( a b ) T ( a b ) ( a b ) d sng hs dfferenal equaon Evan and onkapohja (2) and Bullard and Mra (22) have shown hree equlbrum ondons whh are: (a) DT B( b) (b) () a DT b B I Bb b DT B I Bb The raonal expeaonal equlbrum ( a b ) s E-sable or learnable f all real pars of he egenvalues of DT a DT b and DT are lower han. The soluon s E-unsable f any of hem DT have real par hgher han. Alernavely E-sably holds f all egenvalues of a DT and DT have negave real pars. Bullard and Mra (22) have shown ha hese E- b sably ondons aually govern sably under adapve learnng and herefore really helpful o undersand behavor of alernave moneary poly rules n more omplex se of DSGE models. 29 See MCallum (983) for more deals on hs soluon form. -5-

53 APPENDEX-C: Model Calbraon Resuls Table C: Key Sruural Parameer Values for Model Calbraons (on quarerly bass) Parameers Desrpon Value Subjeve dsoun faor.99 ĥ Degree of hab formaon.36 M Relave wegh n preferenes assgned o real money balanes.25 Sem-elasy of money demand o neres rae -.5 Inverse of wage elasy of labor supply.5 Share of ore goods n he onsumpon baske.75 C Elasy of subsuon beween ore and ol goods onsumpon bundle.35 C Share of formal seor goods n he ore onsumpon baske.55 Elasy of subsuon beween formal and nformal goods onsumpon bundle.7 Share of home goods n he formal onsumpon baske.65 Elasy of subsuon beween home and foregn goods onsumpon bundle.2 Share of formal labor n aggregae labor supply.29 Elasy of subsuon beween formal and nformal labor 2. Elasy of subsuon beween dfferen labor sklls n he formal seor.8 Share of home nvesmen n aggregae prvae nvesmen.52 Elasy of subsuon beween home and foregn prvae nvesmen.2 Capal depreaon rae.3 Elasy of subsuon beween dfferenaed formal nermedae varees. Fla ax rae on fnal home goods.5 Share of non-ol faor npus n he produon of nermedae formal seor varees.65 Elasy of subsuon beween ol and oher faor of npus n formal produon.85 abor share n formal seor produon funon.54 Elasy of subsuon beween dfferenaed formal nermedae mpored varees.25 F Fla ax rae on fnal mpored goods.5 F Elasy of subsuon beween dfferenaed nformal nermedae varees.78 Share of non-ol faor npus n he produon of nermedae nformal seor varees.75 Elasy of subsuon beween ol and oher faor of npus n nformal produon.95 Calvo degree of pre rgdy n formal seor home goods.24 Indexaon of pre of formal seor home goods.65 Calvo degree of foregn pre rgdy n formal seor home goods.64 Indexaon of foregn pre of formal seor home goods.55 F Calvo degree of pre rgdy n formal seor mpored goods.7 Indexaon of pre of formal seor mpored goods.45 F Calvo degree of pre rgdy n nformal seor home goods.2 Indexaon of pre of nformal seor home goods.7 Relave wegh of neres rae nera n moneary poly Rule.63 Relave wegh of nflaon n moneary poly Rule.2 Relave wegh of oupu n moneary poly Rule.6 y rer Relave wegh of real exhange rae n moneary poly Rule.5 Share of governmen onsumpon of home goods n aggregae governmen onsumpon.75 Elasy of subsuon beween governmen onsumpon of home and foregn goods.5 share of domes nermedae goods n he onsumpon baske of foregn agens.4 pre elasy of he foregn demand of domes goods

54 Table C2: Daa for Benhmark Model Calbraons (Shok Proess Paramers) Exogenous Shoks Perssene n Shoks ( ) Volaly n Shoks ( ) Transory negave produvy shok n formal seor.86.5 Negave agrulure ommody produon shok Negave foregn ommody pre shok Negave foregn demand shok Posve foregn neres rae shok Posve foregn nflaon pre shok.8.27 Domes gh moneary poly shok.3.3 Domes labor supply shok.85.2 Posve preferene shok Domes fsal poly shok.78.5 Negave nvesmen adjusmen os shok Negave domes nvesmen shok Negave foregn nvesmen shok Posve mpor pre shok Posve nernaonal ol pre shok Permanen negave produvy shok.92.4 Table C3: Daa for Benhmark Model Calbraons (Annualzed Seady Sae Values) Varables Seady Sae Values Formal seor oupu growh 5. % Informal seor oupu growh 3.5% Formal seor overall nflaon 7% Informal seor nflaon 9% Curren aoun o GDP rao 2.5% Formal seor onsumpon o Oupu rao 7% Informal seor onsumpon o nformal oupu rao 75% Domes prvae nvesmen o oupu rao 2% Foregn prvae nvesmen o oupu rao 9% -53-

55 Table C4: Sandard Devaons and Relave Volaly wh Oupu (Calbraon resuls from Baselne verson of he Model) Varables S.D Relave S.D wh Formal Oupu Formal Consumpon Informal Consumpon Formal seor Oupu Informal seor Oupu Agrulure Commody Oupu Inflaon n Formal Seor Inflaon n Informal seor Real Exhange Rae Aggregae abour Aggregae Wages Domes Invesmen Foregn Invesmen Ol Consumpon Domes Ineres Rae Governmen Consumpon Curren Aoun

56 Table C5: Parwse Correlaon Marx (Calbraon resuls from Baselne verson of he Model) Var. Var.2 Var.3 Var.4 Var.5 Var.6 Var.7 Var.8 Var.9 Var. Var. Var.2 Var.3 Var.4 Var.5 Var.6 Var Var Var Var Var Var Var Var Var Var Var Var Var Var Var Var Table Noe: Var. Formal Consumpon Var.5 Agrulure Commody Oupu Var.9 Aggregae abour Var.3 Ol Consumpon Var.2 Informal Consumpon Var.6 Inflaon n Formal Seor Var. Aggregae Wages Var.4 Domes Ineres Rae Var.3 Formal seor Oupu Var.7 Inflaon n Informal seor Var. Domes Invesmen Governmen Var.5 Consumpon Var.4 Informal seor Oupu Var.8 Real Exhange Rae Var.2 Foregn Invesmen Var.6 Curren Aoun -55-

57 Table C6: Auoorrelaons (Calbraon resuls from Baselne verson of he Model) ag Order ag Order 2 ag Order 3 ag Order 4 ag Order 5 Formal Consumpon Informal Consumpon Formal seor Oupu Informal seor Oupu Agrulure Commody Oupu Inflaon n Formal Seor Inflaon n Informal seor Real Exhange Rae Aggregae abour Aggregae Wages Domes Invesmen Foregn Invesmen Ol Consumpon Domes Ineres Rae Governmen Consumpon Curren Aoun

58 Fgure C: Impulse Response o posve nernaonal ol pre shok Formal Consumpon x Aggrulure -7 Seor Oupu Informal Consumpon Inflaon n Formal Seor Formal Seor Oupu Inflaon n Informal Seor x -6 Informal Seor Oupu Real Exhange Rae. -. Aggregae abour Aggregae Wage Index Domes Invesmen Foregn Invesmen Domes Ol Consumpon -.4 x -3 Domes Ineres Rae 5 Domes Governmen Spendng.5.5 Curren Aoun Base lne Poly ess Aggrassve An-Inflaon More Aggressve An-Inflaon ess Aggrassve reaon o oupu More Aggrassve reaon o oupu Fgure C2: Impulse response o negave domes nvesmen shok Formal Consumpon x Aggrulure -7 Seor Oupu Informal Consumpon Inflaon n Formal Seor Formal Seor Oupu Inflaon n Informal Seor x -7 Informal Seor Oupu Real Exhange Rae Aggregae abour.2 Aggregae Wage Index.2. Domes Invesmen Foregn Invesmen Domes Ol Consumpon Domes Ineres Rae -.2 Domes Governmen Spendng Curren Aoun Base lne Poly ess Aggrassve An-Inflaon More Aggressve An-Inflaon ess Aggrassve reaon o oupu More Aggrassve reaon o oupu -57-

59 Fgure C3: Impulse response o negave foregn nvesmen shok Formal Consumpon. Informal Consumpon Formal Seor Oupu x -7 Informal Seor Oupu x Aggrulure -7 Seor Oupu Inflaon n Formal Seor..5 Inflaon n Informal Seor.5..5 Real Exhange Rae Aggregae abour Domes Ol Consumpon Aggregae Wage Index Domes Ineres Rae Domes Invesmen Domes Governmen Spendng Foregn Invesmen Curren Aoun Base lne Poly ess Aggrassve An-Inflaon More Aggressve An-Inflaon ess Aggrassve reaon o oupu More Aggrassve reaon o oupu Fgure C4: Impulse Response o negave nvesmen adjusmen os shok Formal Consumpon x Aggrulure -7 Seor Oupu Informal Consumpon Inflaon n Formal Seor Formal Seor Oupu Inflaon n Informal Seor x -7 Informal Seor Oupu Real Exhange Rae Aggregae abour Aggregae Wage Index Domes Invesmen Foregn Invesmen Domes Ol Consumpon Domes Ineres Rae -4 Domes Governmen Spendng Curren Aoun Base lne Poly ess Aggrassve An-Inflaon More Aggressve An-Inflaon ess Aggrassve reaon o oupu More Aggrassve reaon o oupu -58-

60 Fgure C5: Impulse response o negave foregn demand shok Formal Consumpon x Aggrulure -7 Seor Oupu Informal Consumpon Inflaon n Formal Seor Formal Seor Oupu Inflaon n Informal Seor Informal Seor Oupu Real Exhange Rae Aggregae abour Domes Ol Consumpon Aggregae Wage Index Domes Ineres Rae Domes Invesmen Domes Governmen Spendng Foregn Invesmen Curren Aoun Base lne Poly ess Aggrassve An-Inflaon More Aggressve An-Inflaon ess Aggrassve reaon o oupu More Aggrassve reaon o oupu Fgure C6: Impulse response o negave foregn ommody pre shok. Formal Consumpon -.2 Informal Consumpon. Formal Seor Oupu x -7 Informal Seor Oupu x Aggrulure -7 Seor Oupu. -. Aggregae abour Inflaon n Formal Seor Aggregae Wage Index Inflaon n Informal Seor Domes Invesmen Real Exhange Rae Foregn Invesmen Domes Ol Consumpon x -3 Domes Ineres Rae Domes Governmen Spendng Curren Aoun Base lne Poly ess Aggrassve An-Inflaon More Aggressve An-Inflaon ess Aggrassve reaon o oupu More Aggrassve reaon o oupu -59-

61 Fgure C7: Impulse response o posve mpor pre shok Formal Consumpon 5 x -7 Aggrulure Seor Oupu Aggregae abour Informal Consumpon Inflaon n Formal Seor Aggregae Wage Index Formal Seor Oupu Inflaon n Informal Seor Domes Invesmen x -6 Informal Seor Oupu Real Exhange Rae Foregn Invesmen Domes Ol Consumpon -.8 Domes Ineres Rae -4 Domes Governmen Spendng -6 Curren Aoun Base lne Poly ess Aggrassve An-Inflaon More Aggressve An-Inflaon ess Aggrassve reaon o oupu More Aggrassve reaon o oupu Fgure C8: Impulse response o posve foregn neres rae shok Formal Consumpon x Aggrulure -7 Seor Oupu Aggregae abour Domes Ol Consumpon Informal Consumpon Inflaon n Formal Seor Aggregae Wage Index Domes Ineres Rae Formal Seor Oupu Inflaon n Informal Seor Domes Invesmen Domes Governmen Spendng x -7 Informal Seor Oupu Real Exhange Rae Foregn Invesmen Curren Aoun Base lne Poly ess Aggrassve An-Inflaon More Aggressve An-Inflaon ess Aggrassve reaon o oupu More Aggrassve reaon o oupu -6-

62 Fgure C9: Impulse Response o posve foregn nflaon pre shok Formal Consumpon x Aggrulure -8 Seor Oupu Aggregae abour Informal Consumpon Inflaon n Formal Seor Aggregae Wage Index Formal Seor Oupu Inflaon n Informal Seor Domes Invesmen 5 x -7 Informal Seor Oupu Real Exhange Rae Foregn Invesmen Domes Ol Consumpon.5 Domes Ineres Rae Domes Governmen Spendng Curren Aoun Base lne Poly ess Aggrassve An-Inflaon More Aggressve An-Inflaon ess Aggrassve reaon o oupu More Aggrassve reaon o oupu Fgure C: Impulse response o ransory negave produvy shok n formal seor Formal Consumpon x Aggrulure -8 Seor Oupu Aggregae abour Domes Ol Consumpon Informal Consumpon Inflaon n Formal Seor Aggregae Wage Index Domes Ineres Rae Formal Seor Oupu Inflaon n Informal Seor Domes Invesmen Domes Governmen Spendng x -7 Informal Seor Oupu Real Exhange Rae Foregn Invesmen Curren Aoun Base lne Poly ess Aggrassve An-Inflaon More Aggressve An-Inflaon ess Aggrassve reaon o oupu More Aggrassve reaon o oupu -6-

63 Fgure C: Impulse response o permanen negave produvy shok Formal Consumpon x Aggrulure -7 Seor Oupu Aggregae abour Informal Consumpon Inflaon n Formal Seor Aggregae Wage Index Formal Seor Oupu Inflaon n Informal Seor Domes Invesmen x -7 Informal Seor Oupu Real Exhange Rae Foregn Invesmen Domes Ol Consumpon.4.2 Domes Ineres Rae Domes Governmen Spendng Curren Aoun Base lne Poly ess Aggrassve An-Inflaon More Aggressve An-Inflaon ess Aggrassve reaon o oupu More Aggrassve reaon o oupu Fgure C2: Impulse response o negave agrulure ommody produon shok Formal Consumpon Aggrulure Seor Oupu Aggregae abour Informal Consumpon Inflaon n Formal Seor Aggregae Wage Index Formal Seor Oupu Inflaon n Informal Seor Domes Invesmen x -8 Informal Seor Oupu 5 Real Exhange Rae Foregn Invesmen Domes Ol Consumpon Domes Ineres Rae Domes Governmen Spendng Curren Aoun Base lne Poly ess Aggrassve An-Inflaon More Aggressve An-Inflaon ess Aggrassve reaon o oupu More Aggrassve reaon o oupu -62-

64 Formal Consumpon x Aggrulure -8 Seor Oupu Fgure C3: Impulse response o preferene shok Informal Consumpon Inflaon n Formal Seor.4.2 Formal Seor Oupu Inflaon n Informal Seor -2-4 x -7 Informal Seor Oupu Real Exhange Rae Aggregae abour Domes Ol Consumpon Aggregae Wage Index Domes Ineres Rae.2. Domes Invesmen Domes Governmen Spendng Foregn Invesmen Curren Aoun Base lne Poly ess Aggrassve An-Inflaon More Aggressve An-Inflaon ess Aggrassve reaon o oupu More Aggrassve reaon o oupu Fgure C4: Impulse response o domes labour supply shok Formal Consumpon x Aggrulure -9 Seor Oupu Aggregae abour -. Domes Ol Consumpon Informal Consumpon x Inflaon -3 n Formal Seor Aggregae Wage Index x -4 Domes Ineres Rae Formal Seor Oupu Inflaon n Informal Seor Domes Invesmen -.5 Domes Governmen Spendng x -8 Informal Seor Oupu Real Exhange Rae Foregn Invesmen x -3 Curren Aoun Base lne Poly ess Aggrassve An-Inflaon More Aggressve An-Inflaon ess Aggrassve reaon o oupu More Aggrassve reaon o oupu -63-

65 Fgure C5: Impulse response o domes gh moneary poly shok Formal Consumpon Informal Consumpon Formal Seor Oupu x -6 Informal Seor Oupu x Aggrulure -7 Seor Oupu Aggregae abour Domes Ol Consumpon Inflaon n Formal Seor Aggregae Wage Index Domes Ineres Rae -3 Inflaon n Informal Seor Domes Invesmen Domes Governmen Spendng Real Exhange Rae Foregn Invesmen Curren Aoun Base lne Poly ess Aggrassve An-Inflaon More Aggressve An-Inflaon ess Aggrassve reaon o oupu More Aggrassve reaon o oupu Fgure C6: Impulse response o domes fsal poly shok Formal Consumpon x Aggrulure -8 Seor Oupu Aggregae abour Domes Ol Consumpon Informal Consumpon x Inflaon -3 n Formal Seor x -3 Aggregae Wage Index Domes Ineres Rae..5 Formal Seor Oupu x Inflaon -3 n Informal Seor Domes Invesmen Domes Governmen Spendng x -8 Informal Seor Oupu Real Exhange Rae Foregn Invesmen x -3 Curren Aoun Base lne Poly ess Aggrassve An-Inflaon More Aggressve An-Inflaon ess Aggrassve reaon o oupu More Aggrassve reaon o oupu -64-

66 Table C7: Varane Deomposon (Calbraon resuls from Baselne verson of he Model) Varables\Shoks S. S.2 S.3 S.4 S.5 S.6 S.7 S.8 S.9 S. S. S.2 S.3 S.4 S.5 S.6 Domes Conrbuon Foregn Conrbuon Formal Consumpon % 49.9% Informal Consumpon % 27.% Formal seor Oupu % 52.3% Informal seor Oupu % 25.9% Agrulure Commody Oupu % 52.2% Inflaon n Formal Seor % 2.8% Inflaon n Informal seor % 23.2% Real Exhange Rae % 49.% Aggregae abour % 39.8% Aggregae Wages % 38.7% Domes Invesmen % 44.7% Foregn Invesmen % 34.6% Ol Consumpon % 96.% Domes Ineres Rae % 26.3% Governmen Consumpon % 57.9% Curren Aoun % 35.3% Table Noe: Shok. ransory negave produvy shok n formal seor Shok.9 posve preferene shok Shok.2 negave agrulure ommody produon shok Shok. domes fsal poly shok negave foregn ommody pre Shok.3 Shok. negave nvesmen adjusmen os shok shok Shok.4 negave foregn demand shok Shok.2 negave domes nvesmen shok posve foregn neres rae Shok.5 Shok.3 negave foregn nvesmen shok shok Shok.6 posve foregn nflaon pre shok Shok.4 posve mpor pre shok Shok.7 domes gh moneary poly shok Shok.5 posve nernaonal ol pre shok Shok.8 domes labour supply shok Shok.6 permanen negave produvy shok -65-

67 Varables Formal Table C8: Performane of Alernave Moneary Poly Spefaons Baselne poly * ess aggressve an-nflaon poly *2 More aggressve an-nflaon poly *3 Poly wh less aggressve reaon o oupu *4 Poly wh more aggressve reaon o oupu *5 Consumpon Informal Consumpon Formal seor Oupu Informal seor Oupu Agrulure Commody Oupu Inflaon n Formal Seor Inflaon n Informal seor Real Exhange Rae Aggregae abour Aggregae Wages Domes Invesmen Foregn Invesmen Ol Consumpon Domes Ineres Rae Governmen Consumpon Curren Aoun Welfare oss (Formal Seor) Welfare oss (Informal Seor) Table Noe: */ Correspondng o eah poly rule spefaon peren sandard devaons are gven for eah varable. / Baselne poly:.63 ;.2 ; y.6 and rer.5 2/ ess aggressve an-nflaon poly:.9 ;. ; y 3/ More aggressve an-nflaon poly:.9 ;.65 ; y 4/ Poly wh less aggressve reaon o oupu:.9 ;.2 5/ Poly wh more aggressve reaon o oupu:.9 ;.2 and rer and rer ;.53 and y ;.95 and y rer rer -66-

68 Fgure C7: Deermnay and E-Sably Plos of Moneary Poly Rule (Case wh ess Inera and No reaon o Exhange Rae) Deermnay Regon Fgure Noe: Moneary poly rule s gven as: r = r y rer C y D rer m For hs ase:.63 and rer Fgure C8: Deermnay and E-Sably Plos of Moneary Poly Rule (Case wh More Inera and No reaon o Exhange Rae) y y Indeermnay Regon Indeermnay Regon Deermnay Regon Fgure Noe: Moneary poly rule s gven as: r = r y rer C y D rer m For hs ase:.9 and rer -67-

69 Fgure C9: Deermnay and E-Sably Plos of Moneary Poly Rule (Case wh ess Inera and opmal reaon o Exhange Rae) Fgure Noe: Moneary poly rule s gven as: r = r y rer C y D rer m For hs ase:.63 and rer.5 Fgure C2: Deermnay and E-Sably Plos of Moneary Poly Rule (Case wh More Inera and opmal reaon o Exhange Rae) Deermnay Regon y Indeermnay Regon Deermnay Regon y Fgure Noe: Moneary poly rule s gven as: -68- r = r y rer C y D rer m For hs ase:.9 and rer.5