SOURCES OF MACROECONOMIC FLUCTUATIONS IN SMALL OPEN ECONOMIES

This paper examines the sources of economic fluctuations in seven OECD small open economies. We measure the relative contribution of externa l shocks and country-specific aggregate demand and supply disturbances (internal shocks) in explaining short-term movements of output, infla tion and the trade balance. We find: (i) output fluctuations are prima rily explained by domestic supply shocks, (ii) trade balance movements are explained mostly by domestic absorption shocks, and (iii) spillov er effects of external shocks on the domestic economy are primarily on nominal, rather than real, variables. We conclude that, while domesti c absorption policies like fiscal restraint may improve the trade bala nce, they cannot stabilize output.