International Transmission of Macroeconomic Uncertainty in Small Open Economies: An Empirical Approach

In the new CAMP working paper 12/2018, Cross, Hou and Poon estimate the effects of domestic and international sources of macroeconomic uncertainty in three small open economy inflation targeting countries: Australia, Canada and New Zealand.

Their main result is that international uncertainty spill-overs shape the macroeconomic conditions in all small open economies. The general mechanism is that international uncertainty shocks reduce real GDP, while raising inflation and interest rates. Domestic uncertainty shocks are found to have a similar effect on inflation and interest rates, however the real GDP responses are idiosyncratic. In particular, the transmission of domestic uncertainty shocks is found to be negative in Canada and positive in New Zealand, while the Australian response is initially negative and becomes positive over time. Finally, in a forecasting exercise, they show that accounting for macroeconomic uncertainty via their model specification provides more accurate point and density forecasts compared to commonly used benchmarks.



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