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

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 find 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 effect of Canadian monetary policy.