How Important Are Foreign Shocks in a Small Open Economy? The Case of Slovakia

In this article, we provide evidence on the nature and the relative importance of domestic and foreign shocks -- with a focus on monetary shocks -- in the Slovak economy based on the block-restriction vector autoregression model during the years 1999-2007. We document a well-functioning monetary transmission mechanism in Slovakia. Subject to various sensitivity checks, we find that contractionary monetary policy shock has a temporary negative effect on the degree of economic activity and price level. We find that using output gap instead of GDP alleviates the price puzzle. In general, prices are driven mainly by foreign factors and the European Central Bank monetary policy shock on Slovak prices is more powerful than that of the National Bank of Slovakia. The Slovak Central Bank interest rate policy seems to follow the ECB's interest rates. On the other hand, spectacular Slovak economic growth is primarily driven by domestic factors suggesting the positive role of recently undertaken Slovak economic reforms.