Development and Study of a New Keynesian Small Open Economy Model for Policy Analysis in Sudan, Evidence from DSGE Model

Abstract

The purpose of this paper is to create a small open economy model for monetary policy discussion and analysis. A new Keynesian model for the Sudanese economy is developed using the DSGE technique. The paper made use of annual data from the period (1998 - 2021). The paper demonstrates that, in the case of a fully-fledged Islamic monetary system, the exchange rate can be used as a proxy for the policy rate and yield results that are consistent with what was expected.  The main findings are that when monetary policy shocks occur, an increase in the exchange rate directly leads to a contraction in aggregate demand, the fluctuations in output in the short run are primarily driven by output, inflation, and exchange rate shocks, that the response of the variables to policy shocks is consistent with economic theory and what is expected from the variables, and that the empirical findings of the model demonstrate how models can help in policy discussion and analysis. The policy implications were that Sudanese authorities can use the exchange rate to track the dynamics in monetary policy DSGE models that can be used for discussion and policy analysis, and Sudanese monetary authorities must pay close attention to output fluctuations based on variance decomposition analysis.