Cardiff University

The objective of this paper is to specify a fully articulated model of a medium-sized open economy which we subsequently calibrate using quarterly data for the UK. We construct a dynamic general equilibrium open economy model based on optimising decisions of rational agents, incorporating money, government and distortionary taxes. The first order conditions from the household and firm's optimisation problem are used to derive the behavioural equations of the model. As we model a medium-sized open economy, we take the world economy as given. We keep the model in its non- linear form and hence solve it numerically. The interaction with the rest of the world comes in the form of UIP and current account both of which are explicitly micro-founded. Finally, the paper discusses simulation results for both demand and supply shocks with calibrated parameters which were used to assess the overall properties of the model. The results are consistent with our theoretical priors. Given the well-specified micro foundations of the model it can be used for evaluating welfare implications of nontrivial policy changes without the use of an ad-hoc objective function. ‡We thank Eric Nowell for programming, David Meenagh for help with th