A DSGE Model of Slovakia with Frictional Labor Market and Monetary Regime Switch

The aim of this paper is to examine the dynamical and structural characteristics of Slovakia using a dynamic stochastic general equilibrium model augmented with search and matching mechanisms and other forms of frictions. I implement a switching mechanism to account for the monetary regime change in Slovakia in 2009. My focus lies in the investigation of labor market rigidities that affect the macroeconomic variables. I also examine the long term impact of the recession in 2009 on the Slovak economy. My findings are as follows. Firstly, based on parameter estimates, I identify significant labor market frictions present in the Slovak Republic. Secondly, my results capturing the historical evolution of key macroeconomic variables support the view that the recession in the examined small open economy was mainly caused by shocks originating in the foreign sector. Thirdly, the monetary authority can influence the labor market variables through its transmission channels relatively effectively; and lastly, I discovered that the recession decreased the Slovak economy’s flexibility. While the results of estimations on two sub-samples are quite similar for most of the structural parameters, an increase in price and wage stickiness is observable.