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Economic Fluctuations in a Small Open Economy – Real versus Nominal Shocks

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Abstract

This paper analyses the role of real and nominal shocks in explaining business cycles in a small open economy like that of Norway. In particular, we study the sources behind real exchange rate fluctuations since the collapse of the Bretton Woods agreement. Imposing long run restrictions implied by economic theory on a structural vector autoregression (VAR) model containing GDP, unemployment (or price), real wage and the real exchange rate, four structural shocks are identified; Velocity (or monetary), fiscal, productivity and labour supply shocks. The model is also augmented to allow for oil price shocks.The identified shocks and their impulse responses are consistent with an open economy (Keynesian) model of economic fluctuations, and highlights the exchange rate as a transmission mechanism in a small open and energy based economy. Especially, I have found a plausible sequence of shocks (productivity shocks in the 1970s, velocity shocks in the mid-1980s, productivity and labour supply shocks in the late 1980s, and velocity and fiscal shocks in the early 1990s), which help to explain the evolution of GDP, unemployment, price, real wage and the real exchange rate. The results are robust to alternative specifications of the model and are stable over the sample.

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Bibliographic Info

Paper provided by Research Department of Statistics Norway in its series Discussion Papers with number 215.

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Date of creation: Mar 1998
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Handle: RePEc:ssb:dispap:215

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Keywords: Real and nominal shocks; exchange rate fluctuations; purchasing power parity; dynamic restrictions; structural VAR;

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References

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  1. Jordi Galí & Richard Clarida, 1993. "Sources of real exchage rate fluctuations: How important are nominal shocks?," Economics Working Papers 66, Department of Economics and Business, Universitat Pompeu Fabra, revised Jan 1994.
  2. Eichenbaum, Martin, 1997. "Some Thoughts on Practical Stabilization Policy," American Economic Review, American Economic Association, vol. 87(2), pages 236-39, May.
  3. Jon Faust & Eric M. Leeper, 1994. "When do long-run identifying restrictions give reliable results?," Working Paper 94-2, Federal Reserve Bank of Atlanta.
  4. Gamber, Edward N & Joutz, Frederick L, 1993. "The Dynamic Effects of Aggregate Demand and Supply Disturbances: Comment," American Economic Review, American Economic Association, vol. 83(5), pages 1387-93, December.
  5. David B. Gordon & Eric M. Leeper, 1992. "The dynamic impacts of monetary policy: an exercise in tentative identification," Working Paper 92-13, Federal Reserve Bank of Atlanta.
  6. Christiano, Lawrence J & Eichenbaum, Martin & Evans, Charles, 1996. "The Effects of Monetary Policy Shocks: Evidence from the Flow of Funds," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 16-34, February.
  7. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-80, November.
  8. Ben S. Bernanke & Alan S. Blinder, 1989. "The federal funds rate and the channels of monetary transmission," Working Papers 89-10, Federal Reserve Bank of Philadelphia.
  9. Bernanke, Ben S. & Mihov, Ilian, 1995. "Measuring Monetary Policy," Economics Series 10, Institute for Advanced Studies.
  10. Solow, Robert M, 1997. "Is There a Core of Usable Macroeconomics We Should All Believe In?," American Economic Review, American Economic Association, vol. 87(2), pages 230-32, May.
  11. Cushman, David O. & Zha, Tao, 1997. "Identifying monetary policy in a small open economy under flexible exchange rates," Journal of Monetary Economics, Elsevier, vol. 39(3), pages 433-448, August.
  12. Corden, W Max & Neary, J Peter, 1982. "Booming Sector and De-Industrialisation in a Small Open Economy," Economic Journal, Royal Economic Society, vol. 92(368), pages 825-48, December.
  13. Sims, Christopher A., 1992. "Interpreting the macroeconomic time series facts : The effects of monetary policy," European Economic Review, Elsevier, vol. 36(5), pages 975-1000, June.
  14. Jacobson, Tor & Jansson, Per & Vredin, Anders & Warne, Anders, 1999. "A VAR Model for Monetary Policy Analysis in a Small Open Economy," Working Paper Series 77, Sveriges Riksbank (Central Bank of Sweden).
  15. Blanchard, Olivier, 1997. "Is There a Core of Usable Macroeconomics?," American Economic Review, American Economic Association, vol. 87(2), pages 244-46, May.
  16. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  17. Glenn D. Rudebusch, 1996. "Do measures of monetary policy in a VAR make sense?," Working Papers in Applied Economic Theory 96-05, Federal Reserve Bank of San Francisco.
  18. Marco Lippi & Lucrezia Reichlin, 1993. "The dynamic effects of aggregate demand and supply disturbances: comment," ULB Institutional Repository 2013/10159, ULB -- Universite Libre de Bruxelles.
  19. Blinder, Alan S, 1997. "Is There a Core of Practical Macroeconomics That We Should All Believe?," American Economic Review, American Economic Association, vol. 87(2), pages 240-43, May.
  20. Eika, Kari H & Ericsson, Neil R & Nymoen, Ragnar, 1996. "Hazards in Implementing a Monetary Conditions Index," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 58(4), pages 765-90, November.
  21. Phelps, Edmund S & Taylor, John B, 1977. "Stabilizing Powers of Monetary Policy under Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 163-90, February.
  22. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
  23. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
  24. Hilde Christiane Bjørnland, 1997. "Estimating Core Inflation - The Role of Oil Price Shocks and Imported Inflation," Discussion Papers 200, Research Department of Statistics Norway.
  25. Serletis, Apostolos & Zimonopoulos, Grigorios, 1997. "Breaking Trend Functions in Real Exchange Rates: Evidence from Seventeen OECD Countries," Journal of Macroeconomics, Elsevier, vol. 19(4), pages 781-802, October.
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Citations

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Cited by:
  1. Mehrara, Mohsen & Oskoui, Kamran Niki, 2007. "The sources of macroeconomic fluctuations in oil exporting countries: A comparative study," Economic Modelling, Elsevier, vol. 24(3), pages 365-379, May.
  2. Tatiana Cesaroni, 2008. "Economic integration and industrial sector fluctuations: evidence from Italy," ISAE Working Papers 106, ISTAT - Italian National Institute of Statistics - (Rome, ITALY).
  3. Jaanus Raim, 2004. "The Alternative to the Existing System of the Concepts about Purchasing Power Parity Deviations . Derived from the Estonian Experience," Working Papers 115, Tallinn School of Economics and Business Administration, Tallinn University of Technology.
  4. Mohsen Mehrara, 2006. "Analyzing Exchange Rate Misalignment in Iran Based on Structural VAR Approach," Iranian Economic Review, Economics faculty of Tehran university, vol. 11(1), pages 39-58, winter.
  5. Lanteri , Luis N., 2012. "Choques macroeconómicos al sector externo. Evidencia para la Argentina (1980-2011)/Macroeconomic Shocks to the External Sector. Evidence for Argentina (1980-2011)," Estudios de Economía Aplicada, Estudios de Economía Aplicada, vol. 30, pages 1061 (24 pa, Diciembre.

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