Identifying Aggregate Demand and Supply Shocks in a Small Open Economy

Posted: 24 Jun 2008

See all articles by Walter Enders

Walter Enders

University of Alabama - Department of Economics, Finance and Legal Studies

Stan Hurn

Queensland University of Technology - School of Economics and Finance

Date Written: July 2007

Abstract

The standard Blanchard-Quah (BQ) decomposition forces aggregate demand and supply shocks to be orthogonal. However, this assumption is problematic for a nation with an inflation target. The very notion of inflation targeting means that monetary policy reacts to changes in aggregate supply. This paper employs a modification of the BQ procedure that allows for correlated shifts in aggregate supply and demand. It is found that shocks to Australian aggregate demand and supply are highly correlated. The estimated shifts in the aggregate demand and supply curves are then used to measure the effects of inflation targeting on the Australian inflation rate and level of GDP.

Keywords: JEL classifications: E3, C32

Suggested Citation

Enders, Walter and Hurn, Stan, Identifying Aggregate Demand and Supply Shocks in a Small Open Economy (July 2007). Oxford Economic Papers, Vol. 59, Issue 3, pp. 411-429, 2007, Available at SSRN: https://ssrn.com/abstract=1150581 or http://dx.doi.org/10.1093/oep/gpl029

Walter Enders (Contact Author)

University of Alabama - Department of Economics, Finance and Legal Studies ( email )

P.O. Box 870244
200 Alston Hall
Tuscaloosa, AL 35487
United States
205-348-8972 (Phone)
205-348-0590 (Fax)

Stan Hurn

Queensland University of Technology - School of Economics and Finance ( email )

GPO Box 2434
2 George Street
Brisbane, Queensland 4001
Australia
+61 7 3864 5066 (Phone)
+61 7 3864 1500 (Fax)

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