Capital utilization and habit formation in a small open economy model

Abstract.  This paper shows the effects of endogenous capital utilization and habit formation in consumption on the predictions of a small open economy model calibrated to Canada. Capital utilization improves the fit of the model by increasing the volatility of output, investment, and hours worked, while habit formation improves the fit of the model by improving the dynamic properties of consumption and the current account. It is also shown that while shocks to the world interest rate sometimes improve the fit of the baseline model, they do not improve the fit of the model with capital utilization and habit formation. JEL classification: E32, F32