The anatomy of small open economy trends

Author name: 
Gortz C
Theodoridis K
Thoenissen C

We estimate a novel state-space model to jointly identify international technology trend shocks originating in the US economy as well as shocks that are specific to the UK economy. We further differentiate between technological innovations arising from changes in total factor productivity (TFP) and changes in investment specific technology (IST). The long run restrictions used to identify the structural trends in the data are informed by a standard twocountry structural model. We find that international non-stationary technology shocks explain about 26% of the variance of UK GDP. About two thirds of this contribution is driven by the international IST shock. UK-specific disturbances account for the bulk of the volatility in the data. When estimating the effects of international IST and TFP shocks on the remaining G7 countries, we find results are consistent with those for the UK in that the international productivity shocks play a relevant role in explaining aggregate fluctuations. An impulse response function matching exercise shows that the structural model, which informed the long-run restrictions used in our empirical investigation, can generate dynamics consistent with those in the data.

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