Which Monetary Shocks Matter in Small Open Economies? Evidence from Canada

We investigate the monetary policy transmission in a rep-resentative small open economy-Canada-over the 2000-17 period. By using a novel set of external instruments, we identify the impacts of domestic (Canada) and foreign (United States) monetary shocks on financial and macroeconomic variables in Canada in a unified structural VAR framework. Our results first confirm that domestic monetary policy transmission oper-ates through interest rate, foreign exchange, and credit chan-nels in Canada. The results further suggest that U.S. monetary policy shocks also have sizable effects on financial conditions in Canada, in line with the credit and risk-taking channels of international monetary spillovers. That said, the U.S. mone-tary spillovers into Canadian macroeconomic variables could be offset by the fluctuations in exchange rates and net exports in line with the trilemma hypothesis. Finally, our results are robust to various types of instrumental variables on monetary policy shocks.