Importance of the interactions between Czech and Slovak economy

The paper tries to answer the question to what extent there are interactions between Czech and Slovak economy. For this purpose, a DSGE model of two small open economies with foreign sector is employed. Both small open economies consist of four types of agents: households, firms, importers and monetary authority. Compared to the model framework with one small open economy, the model allows for trade between the small open economies which implies that there are two types of importers according to the origin of the imported goods. The model framework assumes monopolistically competitive firms, complete international financial markets, perfectly competitive labour market and allows for deviations from the law of one price. Four variants of model are estimated using Bayesian method (incorporated in Dynare toolbox for Matlab). The variants differ in the assumptions about interactions between Czech and Slovak economy. The variant that best explains data is used to assess the importance of interactions between these two economies. To complete the assessment of interactions between these two economies, the paper presents forecast error variance decomposition of shocks and shock decomposition of selected variables. The contribution of the paper is in the recommendation for economic policy makers as to whether they should take into account the business cycle of the neighbour economy.