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The world is not enough! Small open economies and regional dependence

  • Knut Are Aastveit

    ()

    (Norges Bank (Central Bank of Norway))

  • Hilde C. Bjørnland

    ()

    (BI Norwegian Business School, University of California and Norges Bank (Central Bank of Norway))

  • Leif Anders Thorsrud

    ()

    (BI Norwegian Business School and Norges Bank (Central Bank of Norway))

This paper bridges the new open economy factor augmented VAR (FAVAR) studies with the recent findings in the business cycle synchronization literature emphasizing the importance of regional factors. That is, we estimate and identify a three block FAVAR model with separate world, regional and domestic blocks and study the transmission of both global and regional shocks to four small open economies (Canada, New Zealand, Norway and UK). The results show that foreign shocks explain a major share of the variance in all countries, most so shocks that are common to the world. However, regional shocks also play an important role, explaining more than 20 percent of the variance in the variables. Hence in small open economies, the world is not enough. The regional factors impact the four countries differently, though, some through trade and some through consumer sentiment. Our findings of a strong transmission of both global and regional shocks to open economies are in sharp contrast to the evidence from recently developed open economy DSGE models.

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File URL: http://www.norges-bank.no/en/Published/Papers/Working-Papers/2011/WP-201116/
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Paper provided by Norges Bank in its series Working Paper with number 2011/16.

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Length: 57 pages
Date of creation: 01 Dec 2011
Date of revision:
Handle: RePEc:bno:worpap:2011_16
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