Analysis of the behaviour of a small open economy in period of dramatic economic events

We study structural changes in the characteristics of the Czech economy and the sources of the recent economic downturn two methods of quantitative analysis: recursive estimation of parameters and shock decomposition. The main tool used for the analysis is a New Keynesian DSGE model following New Open Economy Macroeconomics small open economy concept, which allows for incomplete exchange rate pass-through. We assess the ability of the utilized model to explain recent severe economic downturn. The results suggest that the structural characteristics of the Czech economy, given by the values of structural parameters, have not changed during the recent recession. It also suggests that most of the observed data dynamics in the Czech economy can be attributed to outside causes. In particular, the main driving force of the decline in output was the decline in foreign demand. Using those findings, we produce a conditional forecast of the development of the Czech economy for the years 2010 and 2011.