Modeling monetary policy in a small open economy: evidence from a SVAR model

The primary objective of this study is to examine empirically the effects of monetary policy in a small open economy. This is based on an econometric analysis of ways in which a monetary policy shock affects key macroeconomic variables in New Zealand. To achieve this objective, a parsimonious macroeconometric model is developed using well known Contemporaneous (Short-Run) SVAR techniques. Past empirical research on the effects of monetary policy in closed and open economies found evidence of several anomalies, such as the liquidity, price, exchange rate and forward discount bias puzzles. To resolve these puzzles, the study constructs a Contemporaneous SVAR model (called NZSVAR model) and formulates identification schemes that lead to computation of impulse response functions that are free of these empirical anomalies. The results show that we have successfully modelled monetary policy effects in New Zealand without encountering those anomalous responses often documented in previous literature