An Estimated DSGE Open Economy Model of the Indian Economy with Financial Frictions

We develop an open economy DSGE model of the Indian economy and estimate it by Bayesian Maximum Likelihood methods. We build up in stages to a model with a number of features important for emerging economies in general and the Indian economy in particular: a large proportion of credit-constrained consumers, a financial accelerator facing domestic firms seeking to finance their investment, “liability dollarization” and incomplete exchange rate pass-through. Our estimation results support the inclusion of financial frictions in an otherwise standard small open economy model. The simulation properties of the estimated model are examined under a generalized inflation targeting Taylor-type interest rate rule with forward- and backward-looking components.