Small Open Economy Study for Hong Kong

Abstract

In this paper we derive a dynamic stochastic general equilibrium (DSGE) model, following Gali and Monacelli (2005) for Hong Kong. The model features a small open economy with a currency board. We simulate the model and illustrate impulse response functions, comparing three different monetary rules: PEG, domestic inflation target (DIT) and a Taylor rule.

The model is estimated with conventional Bayesian approach, then we perform model comparison of PEG against other two rules, and PEG wins the overwhelming support of the data. Our results show substantial openness of Hong Kong, and firms reset prices roughly every three quarters. Cyclical variations of Hong Kong seem mostly come from productivity and cost push-up shock. Finally a DSGE-VAR model is estimated, results are similar to DSGE model, however, estimated weight parameter indicates that cross equation restrictions are too stylised to capture the essential dynamics of the data than a pure VAR model.