Swedish Postwar Business Cycles: Generated Abroad or at Home?

The relative importance of foreign and domestic shocks for the Swedish postwar business cycle is examined in a neoclassical stochastic growth model of a small open economy. Since recent research has shown that fiscal policy shocks may be important for business cycles, I extend previous work in the literature by allowing for stochastic fiscal policy. It is found that the introduction of fiscal policy improves the empirical fit of the model, although not significantly so when hours worked are detrended with the HP filter. The results suggest that domestic shocks are more important than foreign shocks for output fluctuations. Among the domestic shocks, innovations in fiscal policy seem to have been more important than technology shocks during this period. Foreign shocks are very important for fluctuations in the real exchange rate and the current account.