Identification of fiscal SVAR-IVs in small open economies

Abstract: We identify fiscal SVAR-IVs by utilizing unexpected variation in the output of trading partner economies, measured by professional forecast errors, to account for the systematic component of fiscal policy. Our identification builds on the small open economy assumption that these forecast errors correlate with output but are exogenous to domestic fiscal policy. In applying our approach to Canada and euro area small open economies we show that the instrument is relevant and find suggestive evidence for its exogeneity. Our baseline estimates for the two-year cumulative spending multiplier are around 1 for Canada and 0.5 for euro area small open economies.