We estimate a new Keynesian open economy dynamic stochastic general equilibrium model of Australia with a large number of shocks, frictions and rigidities, matching a large number of observable time series. We find that both foreign and domestic shocks are important drivers of the Australian business cycle. We also find that the initial impact on inflation of an increase in demand for Australian commodities is negative, because of an improvement in the real exchange rate, although there is a persistent positive effect on inflation that dominates at longer horizons.
Published as: Monetary policy and exchange rate volatility in a small open economy in Review of Economic Studies , Vol. 72, No. 3, 707-734, July, 2005