The Analysis of Business Cycle in a Small Open Economy

Abstract

Purpose - The purpose of this paper is to investigate the effect of structural shocks on the Korean macroeconomy using Dynamic Stochastic General Equilibrium(DSGE). Design/methodology/approach - The small open economy model has been applied with the price rigidity and monopolistic competition assumption. After that, using the Bayesian inference method, the structural model with forward looking variables have been estimated. Findings - First, with the bayesian estimation with prior parameters and distribution, the estimated parameters are consistent with existing results and are within the range of reasonable values. Second, looking at the impulse response functions when the technology shock happens in the model, the aggregate income increases due to the substitution of consumption-leisure and domestic and foreign goods. In addition, as a result of the shock, both domestic and consumer prices decrease. Third, when there is a foreign income shock, the output increases because the export increases and households substitute the domestic goods from the foreign goods. Research implications or Originality - Increasing market opening can increase volatility in domestic output and inflation. Therefore, monetary authorities need to carefully monitor changes in overseas shock factors and analyze economic changes and the propagation mechanism of shocks in detail in order to promote economic stabilization.