A Medium-scale DSGE Model with Labour Market Frictions

The aim of our research is to find the most appropriate approach to the labour market within a DSGE model estimated on the Czech Republic's data. We use slightly modified medium-scale small open economy model originally proposed by Sheen and Wang [10]. This model incorporates a standard set of rigidities such as investment adjustment cost, habit formation, external risk premium, and incomplete exchange rate pass-through. The model allows for two approaches to the labour market - the real wage rigidity specified in spirit of the search and matching models, and the nominal wage rigidity a la Calvo wage setting. The model is estimated on a set of fourteen observable variables, including the unemployment rate. Our research is in the early stage, however, preliminary results suggest that the real wage rigidity is more appropriate modelling approach. Empirical performance of our model is illustrated by means of the variance decomposition and historical shock decomposition of selected observable variables.