Implications of state-dependent pricing for DSGE model-based policy analysis in Indonesia

Abstract

This paper builds a small open economy dynamic stochastic general equilibrium (DSGE) model for Indonesia with state-dependent pricing (SDP) and studies its implications for policy analysis. Variations in the extensive margin of price adjustment under SDP are shown to non-trivially affect the model-generated variance decompositions and impulse responses to various shocks. DSGE model-based policy analyses conducted without this extensive margin feature might therefore lead to inaccurate policy prescriptions. In particular, the SDP model would call for a greater degree of monetary easing in response to the COVID-19 pandemic, than that prescribed by the standard time-dependent pricing (TDP) model.