The Effects of Monetary and Fiscal Policy on Aggregate Demand in a Small Open Economy: An Application of the Structural Error Correction Model

Tetsuya Konuki

No 2000/165, IMF Working Papers from International Monetary Fund

Abstract: This paper empirically analyzes the short-run effects of monetary and fiscal policy on aggregate demand, using the two-step structural error correction method. This method has an advantage over the standard reduced-form error correction method in providing a meaningful interpretation for impulse responses. The results are in sharp contrast to those of the traditional Mundell-Fleming and Dornbusch models: after the monetary (fiscal) policy is relaxed, the home currency depreciates (appreciates) for a substantial period of time, and the aggregate demand first expands (contracts) then gradually returns toward its original path.

Keywords: WP; aggregate demand; fiscal policy; open economy; Monetary and fiscal policy; structural error correction models; nominal exchange rate; Phillips-curve price adjustment equation; equation method; aggregate demand function; GMM estimation; expansionary monetary policy shock; aggregate demand specification; magnifying depreciation; fiscal policy disturbance; level of significance; money demand shock; aggregate demand to monetary and fiscal policy shock; Real exchange rates; Exchange rates; Fiscal stimulus; Demand for money (search for similar items in EconPapers)
Pages: 24
Date: 2000-10-01
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