The focus of this paper is on news-driven business cycles in small open economies.
We make two significant contributions. First, we develop a small open economy
model where the presence of financial frictions permits the replication of business
cycle co-movements in response to news shocks. Second, we use VAR analysis to
identify news shocks using data on four advanced small open economies. We find
that expected shocks about the future Total Factor Productivity generate business
cycle co-movements in output, hours, consumption and investment. We also find
that news shocks are associated with countercyclical current account dynamics.
Our findings are robust across a number of alternative identification schemes