Can structural small open-economy models account for the influence of foreign disturbances?
Date
2010
Authors
Justiniano, Alejandro
Preston, Bruce
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Publisher
Elsevier
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.
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Keywords: Bayesian analysis; benchmarking; computer simulation; correlation; economic analysis; estimation method; inflation; numerical model; real exchange rate; structural adjustment; terms of trade; Canada; United States Bayesian analysis; Exchange rate disconnect; International comovement; Small open economy models; Structural estimation
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Source
Journal of International Economics
Type
Journal article
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2037-12-31
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