Monetary Transmission Mechanism in a Small Open Economy: A Bayesian Structural VAR Approach

This paper develops an open-economy Bayesian structural VAR model for Canada in order to estimate the effects of monetary policy shocks, using the overnight target rate as the policy instrument. I allow the policy variable and the financial variables of the model to interact simultaneously with each other and with a number of other home and foreign variables. When I estimate this over-identified VAR model, I find that the policy shock transmits to real output through both the interest rate and exchange rate channels, and the shock does not induce a departure from uncovered interest rate parity. I also find that the impulse response of the monetary aggregate, M1, does not exactly follow the impulse response of the target rate. Finally, I find that Canadian variables significantly responds to the US federal funds rate shock, and external shocks are an important source of Canadian output fluctuations.

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Working or Discussion Paper
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JEL Codes:
C32; E52; F27
Series Statement:
Working Paper No. 1183

 Record created 2018-06-19, last modified 2020-10-28

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