Internal and external shocks in Hong Kong: Empirical evidence and policy options

This paper estimates a small structural model of the Hong Kong economy using quarterly data for the period 1990 to 2002 on the output gap, CPI, property and import prices, the nominal interest rate and the nominal effective exchange rate. We find that fluctuations in the output gap are mainly driven by external factors, while CPI inflation is also affected by domestic shocks. The paper provides counterfactual simulations of how the economy would have evolved under alternative monetary arrangements. To that end, we simulate the model using an interest rate reaction function of the Taylor type and a Singapore-style reaction function for the nominal effective exchange rate. The results suggest that these regimes would have led to different inflation trajectories but that economic activity would have behaved similarly.