Volatility shocks in markets and policies: What matters for a small open economy like Canada?

We structurally estimate how much stochastic-volatility, relative to first-moment shocks, account for policy, demand or supply fluctuations in Canada. The historical Canadian business cycle is largely due to domestic technology and policy shocks. Time-varying volatilities dominate during times of turmoil and policy-environment changes. Our model-based shock-volatility accounting attributes the early 1980s crisis to international, cost-push, and monetary-policy shock volatilities; the adoption of inflation targeting in the early 1990s to monetary-policy uncertainty; the recessions around the early 1980s and 1990s to investment volatility; and income-tax and capital-gains tax reforms involve relatively large tax-policy uncertainty. • A structural stochastic-volatility accounting of Canada’s business cycle. • Volatility spikes in economic crisis like the 1980s energy crisis and 2008 recession. • Adopting inflation targeting in the 1990s reduced monetary policy volatility. • Income-tax and capital-gains tax reforms significantly increased policy volatility. • Canadian business cycles are largely shielded from external economic volatility.