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):   EFG

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.

(276 K)

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.

This paper is available as PDF (276 K) or via email.

Acknowledgments

Machine-readable bibliographic record - MARC, RIS, BibTeX