Abstract
This paper examines some key propositions of real business cycle theory using a small open-economy framework and a structural vector autoregressive methodology. Identification is achieved by long-run restrictions. The main results from the Canadian economy are that domestic supply shocks are important in explaining short-run fluctuations in output, while real interest rate and terms-of-trade changes are not; an important source of the money-output correlation is output shocks affecting inside money in the short run; and the presence of a causal influence of high-powered money or demand deposits on output is not strongly supported by the data. This paper examines some key propositions of real business cycle theory using a small open-economy framework and a structural VAR methodology. Identification is achieved by long-run restrictions. The main results from the Canadian economy are (i) domestic supply shocks are important in explaining short-run fluctuations in output, while real interest rate and terms of trade changes are not; (ii) an important source of the money-output correlation is output shocks affecting inside money in the short run; and (iii) the presence of a causal influence of high-powered money or demand deposits on output is not strongly supported by the data.
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