Can structural small open-economy models account for the influence of foreign disturbances?

Alejandro Justiniano, Bruce James Preston

Research output: Contribution to journalArticleResearchpeer-review

84 Citations (Scopus)

Abstract

This paper demonstrates that an estimated, structural, small open-economy model of the Canadian economy cannot account for the substantial influence of foreign-sourced disturbances identified in numerous reduced-form studies. The benchmark model assumes uncorrelated shocks across countries and implies that U.S. shocks account for less than 3 of the variability observed in several Canadian series, at all forecast horizons. Accordingly, model-implied cross-correlation functions between Canada and U.S. are essentially zero. Both findings are at odds with the data. A specification that assumes correlated cross-country shocks partially resolves this discrepancy, but still falls well short of matching reduced-form evidence. One central difficulty resides in the model s inability to account for comovement without generating counter factual implications for the real exchange rate, the terms of trade and Canadian inflation.
Original languageEnglish
Pages (from-to)61 - 74
Number of pages14
JournalJournal of International Economics
Volume81
Issue number8
DOIs
Publication statusPublished - 2010
Externally publishedYes

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