Macroeconomic volatility and counterfactual inflation-targeting in Hong Kong

Abstract

The present paper evaluates macroeconomic adjustment in Hong Kong with an estimated dynamic stochastic general equilibrium (DSGE) model under a fixed exchange rate regime. We find that exports and world inflation shocks are the dominant sources of GDP volatility, with the risk premium taking on importance during the Asian crisis after 1997. A counterfactual simulation, assuming a flexible exchange rate regime with inflation targeting, shows that inflation would have decreased slightly, but interest-rate volatility would have increased significantly. The welfare gains from switching out of the currency board system appear to be marginal. © 2012 Blackwell Publishing Asia Pty Ltd.