NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Can Structural Small Open Economy Models Account for the Influence of Foreign Disturbances?

Alejandro Justiniano, Bruce Preston

NBER Working Paper No. 14547
Issued in December 2008
NBER Program(s):Economic Fluctuations and Growth

This paper demonstrates that an estimated, structural, small open economy model of the Canadian economy cannot account for the substantial influence of foreign-sourced disturbances identified in numerous reduced-form studies. The benchmark model assumes uncorrelated shocks across countries and implies that U.S. shocks account for less than 3 percent of the variability observed in several Canadian series, at all forecast horizons. Accordingly, model-implied cross-correlation functions between Canada and U.S. are essentially zero. Both findings are at odds with the data. A specification that assumes correlated cross-country shocks partially resolves this discrepancy, but still falls well short of matching reduced-form evidence.

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Document Object Identifier (DOI): 10.3386/w14547

Published: Justiniano, Alejandro & Preston, Bruce, 2010. "Can structural small open-economy models account for the influence of foreign disturbances?," Journal of International Economics, Elsevier, vol. 81(1), pages 61-74, May. citation courtesy of

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