Transmission of global shocks in small open economies and the interaction with fiscal and monetary policy

For policy institutions in small open economies, it is important to identify sources of foreign shocks as well as to analyze how these shocks transmit into the domestic economy, so as to respond accordingly. However, foreign (whether it is real, nominal o r financial) shocks are largely ignored in the models used for policy analysis in central banks across the world, or if included, identified in a much more ad hoc manner than the domestic shocks. Given the empirical evidence of how the global financial crisis affected countries all over the world, but the weak role foreign shocks play in the policy models in central banks, the first part of this project highlights the transmission of global shocks to small open economies and the interaction with monetar y policy. We focus on both real, nominal and financial disturbances to economic activity. However, not all countries have been hit equally hard by the financial crisis. For the three countries Australia, Canada and Norway, the recent recession has been relatively mild. There can be many factors behind this relatively good performance, such as tight regulation of banks and financial institutions. More importantly, these countries are also resource rich. An increase in commodity prices will therefore incr ease terms of trade, which in turn, can have implied a very different capacity for fiscal manoeuvre during the recent recession. Which factor is most important for explaining this good performance? Is it good policies, good regulation or just good luck (being an exporter of a commodity that happens to increase in value)? To answer these questions one needs to build macroeconomic models that allow for an interaction between commodity prices, asset prices, monetary- and fiscal policy and the real econom y. The second part of this project focuses on the transmission of financial and commodity price shock to the real economy, and the interaction with monetary and fiscal policy.