International Transmissions of Aggregate Macroeconomic Uncertainty in Small Open Economies: An Empirical Approach

We estimate the effects of domestic and international sources of macroeconomic
uncertainty in three commonly studied small open economies (SOEs): Australia, Canada
and New Zealand. To this end, we propose a common stochastic volatility in mean panel
VAR (CSVM-PVAR), and develop an efficient Markov chain Monte Carlo algorithm to
estimate the model. Using a formal Bayesian model comparison exercise, our in-sample
results suggest that foreign uncertainty spillovers shape the macroeconomic conditions
in all SOEs, however domestic uncertainty shocks are important for Australia and
Canada, but not New Zealand. The general mechanism is that foreign uncertainty
shocks reduce real GDP and raise inflation in all SOEs, however the interest rate
responses are idiosyncratic; being positive in Australia and New Zealand, and negative
in Canada. Conversely, domestic uncertainty shocks tend to raise all three
macroeconomic variables. Finally, in a pseudo out-of-sample forecasting exercise, the
proposed model also forecasts better than traditional PVAR and CSV-PVAR
benchmarks.