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Can Structural Small Open Economy Models Account for the Influence of Foreign Disturbances?

  • Alejandro Justiniano
  • Bruce Preston

    ()

    (Economics Department Columbia University)

This paper evaluates whether an estimated, structural, small open economy model of the Canadian economy can account for the substantial influence of foreign-sourced disturbances identified in numerous reduced-form studies. The analysis shows that the benchmark model --- and a number of variants which include a range of market imperfections --- imply cross-equation restrictions that are too stringent when confronted with the data, yielding implausible parameter estimates. While appropriate choice of ad hoc disturbances can relax these cross-equation restrictions and therefore capture certain properties of the data --- for instance, the volatility and persistence of the real exchange rate --- and yield plausible parameter estimates, this success is qualified by the model's inability to account for the transmission of foreign disturbances to the domestic economy: less than one percent of the variance of output is explained by foreign shocks

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 479.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:479
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