Investment‐specific shocks and external balances in a small open economy model

Abstract

Abstract. We set up a standard small open economy business cycle model driven by government spending shocks, neutral productivity (TFP) shocks, and investment‐specific shocks. The model is calibrated to quarterly Canadian data and its predicted moments and sample paths are compared with their Canadian counterparts. We find that the model captures the dynamics in investment and in the trade balance better than special cases of the model where either one of the productivity shocks is omitted. More specifically, the model matches the variance of the trade balance‐output ratio, its correlation with output and its autocorrelation. It also matches the output‐investment correlation.

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