Bayesian estimation of a new Keynesian policy model for a small open economy

Abstract

The estimation of dynamic stochastic general equilibrium (DSGE) models has gained momentum during the last decade. In this paper, we estimate a small scale new Keynesian model for an emerging economy, Tunisia. We study the transmission channels of monetary policy on the fluctuations of domestic output and inflation over the short and long run in open and closed economy settings. We find that domestic shocks have higher impact on monetary policy calibration and the dynamic of the internal demand. The inclusion of the working capital channel for a country like Tunisia exhibiting high level of indebtedness of local firms helps better describe the behaviour of macroeconomic variables in response to shocks emanating from the policy side. We show that the policy reaction parameters of the Central Bank confirm our hypothesis that the latter has been following closely the Taylor rule. This finding explains the recent inflation trend in the country.