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Foreign shock transmission in small open economies

Author

Listed:
  • Alejandro Justiniano

    (Board of Governors of the Federal Reserv)

  • Bruce Preston

    (Columbia University)

Abstract

This paper evaluates whether an estimated, structural, small open economy model of the Canadian economy can account for the substantial influence of foreign-sourced disturbances identified in numerous reduced-form studies. The analysis shows that the benchmark model --- and a number of variants which include a range of market imperfections --- imply cross-equation restrictions that are too stringent when confronted with the data, yielding implausible parameter estimates. While appropriate choice of ad hoc disturbances can relax these cross-equation restrictions and therefore capture certain properties of the data --- for instance, the volatility and persistence of the real exchange rate --- and yield plausible parameter estimates, this success is qualified by the model's inability to account for the transmission of foreign disturbances to the domestic economy: less than one percent of the variance of output is explained by foreign shocks

Suggested Citation

  • Alejandro Justiniano & Bruce Preston, 2006. "Foreign shock transmission in small open economies," Computing in Economics and Finance 2006 434, Society for Computational Economics.
    • Handle: RePEc:sce:scecfa:434
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