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The impact of foreign stock markets on macroeconomic dynamics in open economies: A structural estimation

  • Milani, Fabio

With the increased international financial integration in recent years, bilateral financial linkages between countries may have a growing influence on their real economies. This paper employs a structural two-country New Keynesian model, which incorporates a cross-border wealth channel, to estimate the effect that foreign stock market fluctuations may have on macroeconomic variables in open economy countries. The model is estimated using Bayesian methods on a sample of open economies that can potentially be affected by changes in a larger foreign stock market: Australia, Canada, New Zealand, Ireland, Austria, and the Netherlands. The estimation allows for deviations from rational expectations and for learning by economic agents. The empirical results indicate important cross-country wealth effects for Ireland and Austria, from fluctuations in the U.S. and U.K. and in the U.S. and German stock markets, respectively; the wealth effect is largest in Ireland. The data favor, instead, specifications with no significant wealth effect for the remaining countries. Foreign stock price fluctuations, however, still play a role by affecting domestic expectations about future output gaps in all countries in the sample.

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Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 30 (2011)
Issue (Month): 1 (February)
Pages: 111-129

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Handle: RePEc:eee:jimfin:v:30:y:2011:i:1:p:111-129
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