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Effects of Foreign and Domestic Monetary Policy in a Small Open Economy: the Case of Chile

  • Eric Parrado

This paper considers empirical evidence for a small open economy, characterizing and identifying the dynamic effects of both foreign and monetary policy shocks on Chilean macroeconomic variables. A structural VAR approach is used with non-recursive contemporaneous restrictions. Several interesting results appear in the analysis. First, consistent with the predictions of a stochastic rational expectations model, a domestic monetary contraction generates a transitory fall in output and monetary aggregates. Second, there is no evidence of price and exchange rate puzzles. Third, the source of Chilean output, price level, and real exchange rate volatility is similar to that identified in industrial countries: monetary policy explains a relatively small proportion of output, price level, and exchange rate variability. Finally, foreign monetary policy innovations have very short-lived effects on domestic interest rates and have no major influence over other Chilean macroeconomic variables; while risk premium shocks influence significatively both the interest rate and the exchange rate.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 108.

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Date of creation: Sep 2001
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Handle: RePEc:chb:bcchwp:108
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  1. Grilli, Vittorio & Roubini, Nouriel, 1996. "Liquidity models in open economies: Theory and empirical evidence," European Economic Review, Elsevier, vol. 40(3-5), pages 847-859, April.
  2. Richard H. Clarida & Mark Gertler, 1997. "How the Bundesbank Conducts Monetary Policy," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 363-412 National Bureau of Economic Research, Inc.
  3. Olivier J. Blanchard & Mark W. Watson, 1984. "Are Business Cycles All Alike?," NBER Working Papers 1392, National Bureau of Economic Research, Inc.
  4. Vittorio Grilli & Nouriel Roubini, 1995. "Liquidity and Exchange Rates: Puzzling Evidence from the G-7 Countries," Working Papers 95-17, New York University, Leonard N. Stern School of Business, Department of Economics.
  5. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1997. "Sticky price and limited participation models of money: A comparison," European Economic Review, Elsevier, vol. 41(6), pages 1201-1249, June.
  6. Francisco Rosende & Luis Oscar Herrera, 1991. "Teoría y Política Monetaria: Elementos para el Análisis," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 28(83), pages 55-94.
  7. Kim, Soyoung & Roubini, Nouriel, 2000. "Exchange rate anomalies in the industrial countries: A solution with a structural VAR approach," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 561-586, June.
  8. Bernanke, Ben S & Blinder, Alan S, 1992. "The Federal Funds Rate and the Channels of Monetary Transmission," American Economic Review, American Economic Association, vol. 82(4), pages 901-21, September.
  9. David O. Cushman & Tao Zha, 1995. "Identifying monetary policy in a small open economy under flexible exchange rates," Working Paper 95-7, Federal Reserve Bank of Atlanta.
  10. David B. Gordon & Eric M. Leeper, 1993. "The dynamic impacts of monetary policy: an exercise in tentative identification," Working Paper 93-5, Federal Reserve Bank of Atlanta.
  11. Kim, Soyoung, 1999. "Do monetary policy shocks matter in the G-7 countries? Using common identifying assumptions about monetary policy across countries," Journal of International Economics, Elsevier, vol. 48(2), pages 387-412, August.
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