Analyzing the Czech Output Gap Using a Small Open Economy DSGE Model

This contribution uses a simple New Keynesian DSGE model to examine the Czech output gap from 1996 to 2010. We estimate the DSGE model in order to obtain trajectories of exogenous shocks. We test the estimated model for its data-matching properties to show that is sufficiently approximates the real economy. Based on the model, we decompose the deviation of output from trend into contributions of the exogenous shocks. This decomposition allows us to interpret the economic sources of the fluctuations in the output gap. We show that since the year 2000, the foreign demand shock and the exchange rate shock have been increasingly important for the domestic business cycle. Overall, domestic shocks account for more than a half of the variance in the domestic output gap. We contrast the recession of 1997-1998, caused primarily by domestic shocks, to the recession of 2009, which was caused by a drop in the foreign demand. We also find that the Czech economy is sensitive to the exchange rate movements, as documented by year 2002.