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We build an equilibrium model of a small open economy with labor market frictions and imperfectly enforced regulations. Heterogeneous firms sort into the formal or informal sector. We estimate the model using data from Brazil, and use counterfactual simulations to understand how trade affects economic outcomes in the presence of informality. We show the following: 1) Trade openness unambiguously decreases informality in the tradable sector but has ambiguous effects on aggregate informality. 2) The productivity gains from trade are understated when the informal sector is omitted. 3) Trade openness results in large welfare gains even when informality is repressed. 4) Repressing informality increases productivity but at the expense of employment and welfare. 5) The effects of trade on wage inequality are reversed when the informal sector is incorporated in the analysis. 6) The informal sector works as an "unemployment buffer" but not a "welfare buffer" in the event of negative economic shocks.

In this paper we analyse to what extent the Nordic economies are vulnerable to external shocks. Specifically, we assess the conventional wisdom that the Nordic countries are small open economies that are significantly engaged in international trade, specialised in only few specific industries and, as a consequence, extremely dependent on the competiveness of their tradable sector and exposed to external shocks. To study this conventional wisdom, we employ a comprehensive set of indicators about trade openness, specialisation and vulnerability. While we do find that the Nordic countries are open economies, though not to an exceptional degree, we also find significant heterogeneity across these countries with respect to their vulnerability.

This paper builds a model of sovereign debt in which default risk, interest rates, and debt depend not only on current fundamentals but also on news about future fundamentals. News shocks affect equilibrium outcomes because they contain information about the likelihood that the government repays its debt in the future. First, in the model with news shocks not all defaults occur in bad times, bringing the model closer to the data. Second, the news shocks help account for key differences between developing and more developed economies: as the precision of news improves, the model predicts lower variability of consumption, less countercyclical trade balance and interest rate spreads, as well as a higher level of debt more in line with the characteristics of more developed economies. Third, the model also captures the hump-shaped relationship between default rates and the precision of news obtained from the data. Finally, the news shocks have a nonmonotonic effect on the welfare.

This thesis consists of an introductory chapter and three essays, all of which aim to study the functioning of a small open economy. The thesis starts with an investigation of export and import price determination and moves to a small open economy DSGE model framework in order to study the role of financial factors in economic fluctuations. In all three essays, theoretical small open economy models are used for quantitative analysis of the small open economy of Finland. The first essay develops a model for aggregate trade price inflation that takes into account two price setting conventions: local currency pricing (LCP) and producer currency pricing (PCP). In our empirical work, we confront our model with Finnish data and estimate the relative shares of LCP and PCP firms in the economy. In the estimation period 1980 1998, the share of local currency pricing was 40 percent in the export sector and 60 percent in the import sector, implying a limited pass-through from exchange rate to destination-country prices in both sectors. The second essay builds a small open economy DSGE model with the BGG financial accelerator and financial market shocks. In our empirical work covering the period 1995 2008, we provide evidence of an operative financial accelerator in Finland. The financial accelerator acts as an amplifying mechanism for many disturbances hitting the Finnish economy. Our main result is that financial market disturbances have contributed significantly to Finnish cyclical fluctuations between 1995 and 2008. Even allowing for several shocks stemming from both domestic sources and the international economy, domestic financial market shocks emerge as key drivers of recent business cycle fluctuations in Finland. The third essay studies the boom-bust period in Finland in the late 1980s and early 1990s, focusing on the role of financial factors and investment behaviour. We construct a small open economy DSGE model with the BGG financial accelerator and an unconventional shock structure that captures the key events of the episode. In this model framework, we study the role of financial market deregulation in the boom, the negative impact of the collapse of Soviet-Finnish trade in 1991, and the effect of the collapse of the fixed exchange rate regime in 1992. We argue that the financial accelerator mechanism is a key amplifying mechanism that helps the model to match, in particular, the large and persistent swings of investment first above and later below its trend. This essay demonstrates that the shocks Finland encountered combined with financial frictions are able to produce a boom and a severe depression, matching key salient features of the actual boom-bust cycle experienced in Finland in the late 1980s and early 1990s. Väitöskirja koostuu johdannosta ja kolmesta tutkimusluvusta, joiden tutkimuskohteena on pienen avoimen talouden toiminta. Väitöskirjassa tutkitaan ensin vienti- ja tuontihintojen määräytymistä, minkä jälkeen tarkastellaan rahoitustekijöiden merkitystä reaalitalouden vaihteluissa. Kaikissa kolmessa tutkimusluvussa teoreettisia pientä avotaloutta kuvaavia malleja käytetään Suomen talouskehityksen kvantitatiiviseen analyysiin. Ensimmäisessä tutkimusluvussa kehitetään kansainvälisesti kaupattavien hyödykkeiden inflaatiokehitystä kuvaava malli, jossa ulkomaankaupan hinnat voivat olla jäykkiä joko ostajan valuutassa (hinnoittelu paikallisen valuutan määräisenä) tai myyjän valuutassa (hinnoittelu tuottajan valuutan määräisenä). Empiirisessä työssä estimoidaan Suomen tilastotietoja käyttäen ostajan ja myyjän valuutassa hinnoittelevien yritysten suhteellinen osuus taloudessa. Estimointiajanjaksona 1980 1998 ostajan valuutassa hinnoittelevien yritysten estimoitu osuus oli 40 % vientisektorilla ja 60 % tuontisektorilla. Näin ollen valuuttakurssin läpimeno kohdemaan tuontihintoihin oli estimointiajanjaksolla epätäydellinen sekä vienti- että tuontisektorilla. Toisessa tutkimusluvussa rakennetaan pienen avotalouden makromalli, jossa rahoitusmarkkinoiden toiminta vaikuttaa reaalitalouteen erityisesti investointien kautta. Ajanjaksoa 1995-2008 koskevien tulosten mukaan Suomen taloudessa toimii ns. rahoitusakseleraattori, jonka takia investointeja varten tarvittavan ulkoisen rahoituksen hinta riippuu lainanottajien taseiden vahvuudesta. Rahoitusakseleraattori voimistaa monien Suomen talouteen kohdistuvien sokkien vaikutuksia. Lisäksi tutkimuksessa osoitetaan, että yllättävät muutokset lainanottajien rahoituskustannuksissa (ns. rahoitusmarkkinasokit) selittävät suuren osan investointien ja sitä kautta kokonaistuotannon suhdannevaihteluista Suomessa vuosina 1995-2008. Kolmannessa tutkimusluvussa tutkitaan Suomen talouden ylikuumenemista 1980-luvun lopulla sekä 1990-luvun alun lamaa keskittymällä erityisesti rahoitustekijöiden ja investointien merkitykseen. Työssä rakennetaan pienen avotalouden makromalli, jossa on rahoitusakseleraattori sekä sokkirakenne, joka formalisoi aikakauden keskeiset tapahtumat. Tässä mallikehikossa arvioidaan rahoitusmarkkinoiden vapauttamisen merkitystä 1980-luvun talouden ylikuumenemisessa, vuoden 1991 Suomen Neuvostoliiton-kaupan romahduksen epäsuotuisia vaikutuksia sekä vuoden 1992 kiinteästä valuuttakurssijärjestelmästä luopumisen vaikutuksia. Keskeinen tutkimustulos on, että rahoitusakseleraattorilla on tärkeä sokkien seurauksia voimistava vaikutus, mikä auttaa mallia toistamaan erityisesti investointien suuret ja pitkäaikaiset vaihtelut trendinsä ylä- ja alapuolelle. Tässä tutkimusluvussa osoitetaan, että Suomeen kohdistuneet sokit yhdistettynä rahoitustekijöihin pystyvät aikaansaamaan talouden ylikuumenemisen ja syvän laman ja toistamaan Suomen 1980-luvun lopun ja 1990-luvun alun toteutuneen talouskehityksen keskeiset piirteet.

In this paper we present an analysis of the impact of the great recession of the years 2008 and 2009 on the Austrian economy. For this purpose, we utilize the new estimated DSGE model of the OeNB for the Austrian economy within the Euro area. This model is a small open-economy version of Smets & Wouters (2003), where the domestic economy is linked to a highly stylized representation of the rest of the Euro area via trade and financial flows. The model identifies foreign demand and confidence shocks as the main transmission channels. Moreover the risk premium shock contributed significantly to the downturn of the Austrian economy. In contrast price shocks (price markup and raw material shocks) were supportive throughout the crisis. The strong resilience of the Austrian labour market during the crisis and the subsequent upswing is reected in a series of negative technology shocks.

This paper simulates the impact of a short-term shock originating from the global financial system on small open economies in the Association of Southeast Asian Nations (ASEAN). The simulation uses empirically estimated general equilibrium models for Indonesia, Malaysia, the Philippines, and Thailand. The study finds that the impact of a pure international financial shock on aggregate domestic price inflation and on output gap for each of the four ASEAN countries tends to be relatively small but long-lasting, placing challenges in the medium- to long-term management of economic volatility.

This study investigates the implications of risk premium shocks for aggregate fluctuations in a small open economy with financial and informational frictions. A dynamic, stochastic, general equilibrium framework is developed, where the informational asymmetries among the agents in the model and the uncertainty in the production process necessitate financial intermediation in the economy. The Holmstrom-Tirole type of uncertainty in the production process also leads to collateralized borrowing by firms, with the physical capital stock of firms serving as the collateral as well as the factor of production. There is also a government sector in the economy that borrows domestically with a partial default risk. In order to compensate the lenders for the default risk included in the government bonds, the government has to offer them some risk premium in addition to the exogenously given world interest rate offered by the foreign bond issuers. It is shown that, under certain circumstances, it is possible for the government to reduce its debt and increase its spending in response to a positive, temporary risk premium shock.

This paper studies the transmission of shocks and the trade-offs between stabilizing CPI inflation and alternative measures of the output gap in Ramses, the Riksbank's empirical dynamic stochastic general equilibrium (DSGE) model of a small open economy. The main results are, first, that the transmission of shocks depends substantially on the conduct of monetary policy, and second, that the trade-off between stabilizing CPI inflation and the output gap strongly depends on which concept of potential output in the output gap between output and potential output is used in the loss function. If potential output is defined as a smooth trend this trade-off is much more pronounced compared to the case when potential output is defined as the output level that would prevail if prices and wages were flexible.

We study the transmission of monetary shocks and monetary policy with a behavioral model, corrected for potential misspecification using the DSGE-VAR framework elaborated by DelNegro and Schorfheide (2004). In particular, we investigate if the central bank should react to movements in the nominal exchange rate. We contribute to the empirical literature as we use Swiss data, which is very rarely used in that context.

This paper studies the effects and the transmission mechanism of unexpected monetary policy shocks in an open economy setting within the context of a VAR frame- work. It considers an economy with two sectors, a tradable sector and a non-tradable sector. For a given country, economic sectors are defined according to the proportion of output that is exported to other countries. This paper departs from the standard literature in that it tries to isolate the differential effects that monetary policy shocks may have on these two distinct sectors of the economy. The results show that the behavior of these two sectors varies whithin a country, with the tradable sector showing a higher degree of responsiveness to policy shocks than the non-tradable. This result is robust across the different countries in the sample and for a synthetic aggregate. The evidence presented gives an indication that industrial structure may be an important component for the analysis of monetary policy.

If floating exchange rates stabilize shocks rather than create shocks, a country that joins a monetary union or fixes its exchange rate looses a stabilizing mechanism. We use a first difference structural VAR on trade weighted macroeconomic data to study the role of floating exchange rates for five small open economies with inflation targets. By including both domestic and foreign variables and using a combination of long and short-run restrictions, we identify asymmetric shocks more carefully than previous studies. Only in Sweden and Canada does the nominal exchange rate appreciate significantly in response to asymmetric demand shocks and depreciate to asymmetric supply shocks. Most exchange rate movements are caused by speculation and are not responses to fundamental shocks. However, these exchange rate shocks have negligible effects on output and inflation. Our findings indicate that exchange rates are neither stabilizing nor destabilizing but may be loosely characterized as disconnected from the rest of the economy.

We analyze several identification frameworks based on operating procedures to measure monetary policy in a small open economy. We use a two-stage non-recursive VAR model to identify monetary shocks. We construct then various overall monetary policy indicators based on different residuals treatments and report them as weighted sums of monetary policy variables. Finally, our model is applied to the Swiss National Bank. Our main indicator reveals that the exchange rate was the dominant variable at the end of the seventies. During the eighties, aggregates had their golden age, while in the nineties, the call rate showed up as operating variable.