Government Spending and Productivity Shock in a Small Open Economy

Abstract

This paper tries to better explain the business cycle data in a small open economy. We consider two shocks generating the dynamics of the model, a domestic productivity shock, on the domestic productivity, and a government spending shock, generating positive correlations between savings and investment without overestimating or underestimating the pro-cyclical behaviors of the two as in Mendoza (1991). We use stationary cardinal utility functions (SCU) to make discount factor endogenous to the model. We also incorporate different capital adjustment cost in private and public sector to explain the counter-cyclical fluctuations of trade balance. In line with Mendoza (1991), we use post-war Canadian business cycle data as the target of our calibration. The results have been significantly improved in most of the moments among interested variables.