How Much Price Stickiness in Hong Kong? —Evidence from Small Open Economy DSGE and Indirect Inference

Hong Kong is seen as a flexible economy for its free movement of capital and perfect competitive business environment, but most researches either take this background as a default to set the flexible price, or take priors in other economies as a starting point of estimation and they are not tested against data. This paper studies the price stickiness in Hong Kong through the small open economy DSGE model with currency board features. Three models, the flexible price, the sticky price and sticky price with indexation, are estimated and tested by Indirect Inference. We find that sticky price model and sticky price with indexation model match the data behaviour in Hong Kong better, but the testing power for sticky price with indexation is weaker. Although we believe there is sticky price in Hong Kong, the estimation indicates a low level of stickiness. Sticky price and Phillips curve generate additional transmission channel so that prices’ response to foreign monetary policy are stronger, but this mechanism is not observed in other shocks.