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A Small Open Economy New Keynesian Model For A Foreign Exchange Constrained Economy

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Executive Summary

Firms in many low income countries depend entirely on imported capital and intermediate inputs. As a result, in these countries economic activity is considerably influenced by the capacity of the economy to import these inputs which, in turn, depends on the availability and cost of foreign exchange. In this paper the authors introduce foreign exchange availability as an additional constraint faced by firms into an otherwise standard small open economy New Keynesian DSGE model. The model is then calibrated for a typical Sub Saharan African economy and the behavior of the model in response to both domestic and external shocks is compared with the standard model.

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