Currency board and full exchange intervention in HKsmall open economy DSGE with indirect inference assessment

This thesis studies the economy of Hong Kong through the lens of a small open economy DSGE model with a currency board exchange rate commitment. It assumes flexible prices and a banking system that provides credit to entrepreneurial household-firms, with both collateral and cost of verification. We estimate and evaluate the model by Indirect Inference over the sample period of 1994Q1-2018Q3; we find that it matches the data behaviour, as represented by a VAR. We also evaluate a second version of the model in which there is a housing collateral constraint on consumers as in Iacoviello and Neri (2010), and widely used in Hong Kong modelling. However, this version is rejected by the Hong Kong data. In addition, we find out that the housing market has no role in the economy as the housing demand shock accounts for nearly zero, even in the estimated collateral model. We examined the economy’s volatility using bootstrapping of the model innovations, under both the estimated currency board model and a standard alternative regime with floating exchange rate and a Taylor rule; we found that Hong Kong welfare is higher in the currency board, as it substantially reduces output and inflation volatility.