Sources of Macroeconomic Fluctuations in a Volatile Small Open Economy

Abstract

This paper studies the sources of macroeconomic fluctuations in a typical small open economy, Turkey, using a structural vector autoregressive (SVAR) model. The study finds that supply-side shocks are the main source of output fluctuations in the long run, explaining almost half the variance of domestic output. However, most of the short-run variability in domestic output is dominated by relative demand shocks. Aggregate demand shocks do not appear to play any significant role in output fluctuations in the long run. Changes in fiscal policy play a moderate role in determining the real exchange rate in the short term, while changes in world output and prices of imported inputs are the major determinants of the long-term real exchange rate. The long-run price variations are mainly due to oil price and world output shocks.