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Date Submitted: 09/16/2012 10:45 PM

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Monetary Transmission in a Small Open Economy: More Data, Fewer Puzzles

Jean Boivin Bank of Canada Marc P. Giannoni Columbia Universityy Dalibor Stevanovi´ c Université de Montréalz


Abstract This paper analyzes the monetary transmission mechanism in Canada using a factor-augmented vector autoregression (FAVAR) model. For small open economies like Canada, uncovering the transmission mechanism of monetary policy using VARs has proven to be an especially challenging task. Such analyses on Canadian data have often documented the presence of anomalies such as a liquidity, price or exchange rate puzzles. We estimate a FAVAR model using an unbalanced data set of 348 monthly and 87 quarterly macroeconomic time series. We …nd that the information summarized by the factors is important to properly identify the monetary transmission mechanism in both monthly and quarterly frequencies and contributes to mitigate the puzzles mentioned above, suggesting that more information does help. Finally, the FAVAR framework allows us to check impulse responses for all series in the informational data set, and thus provides the most comprehensive picture to date of the e¤ect of Canadian monetary policy.

Keywords: Monetary policy, structural factor analysis, factor-augmented VAR. JEL codes: E52, E58, C32

The …rst two authors thank the NSF for support of the authors’research under the grant SES-0518770. Columbia Business School, 3022 Broadway, Uris Hall 824, New York, NY 10027. E-mail: z E-mail:


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Conclusions about the role that monetary policy plays in the economy and how it should be conducted in practice depend crucially on the way monetary policy affects the economy. This is why a large empirical literature has attempted to measure the transmission of monetary policy. A standard approach to...