Assessing the fit of small open economy DSGEs

We describe a simple extension of the Monacelli (2005) small open economy model that incorporates a non-tradable good, habit persistence and price indexation. The empirical fit of eight different specifications of this model is then tested in a Bayesian framework using data for three small open economies; Australia, Canada, and New Zealand. The results show that the model with a non-tradable good fits the data better than the one-good model across all specifications considered. In contrast to Rabanal and Rubio-Ramarez (2005), we find that adding price indexation to either the one- or two-good model deteriorates overall empirical fit.