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Towards a Strucrural VAR Model of the Australian Economy
Abstract
We develop a ten variable structural VAR model of the Australian economy for the period 1980 to 1995. The VAR methodology has not been widely applied in the Australian context, despite its popularity in quantitative macroeconomics internationally.
... Using monthly data from January 1980 to May 2006, a ninedimensional SVAR model -which includes both the domestic and foreign variables -was set up to study the dynamic responses of the Malaysian economy to domestic and foreign shocks. Further, to impose the necessary identifying restrictions on the contemporaneous and the lag structure of the SVAR model, we used the results of the existing Malaysian VAR models and the SVAR models of advanced small open economies (see, for example, Cushman and Zha (1997) and Dungey and Pagan (2000)) as guides. The identified SVAR model is then used to evaluate to what extent the 1997 Asian crisis and the subsequent shift from the managed float exchange rate regime to pegged exchange rate system have affected the conduct of monetary policy in Malaysia. ...
... In this section, the identification of the Malaysian SVAR model is established. A common approach in the literature is to apply identification restrictions that are consistent with economic theory and prior empirical research findings (see Buckle et al (2007), Christiano et al (2005), Dungey and Fry (2003) and Dungey and Pagan (2000)). 19 In this paper, to establish the identification conditions, the results of Malaysian VAR studies and those of the SVAR studies of advanced small open economies are used to guide us in obtaining the appropriate restrictions to be imposed on the contemporaneous and the lagged structure of the Malaysian SVAR model. ...
This paper employs a structural vector autoregression (SVAR) model to investigate the monetary policy framework of a small emerging open economy -Malaysia, especially how the economy dynamically respond to money, interest rate, exchange rate and foreign shocks. We establish identification conditions to uncover the dynamic effects of monetary policy shocks on various domestic variables. Following the financial crisis in July 1997, Malaysia adopted a pegged exchange regime in September 1998. By analysing the intensity of the responses of the domestic variables to various monetary shocks, we aim to find out whether the Malaysian monetary transmission mechanism has changed in the post-crisis period. Using monthly data from January 1980 to May 2006, a nine variable SVAR model is established to study the dynamic responses of the Malaysian economy to domestic and foreign shocks. The empirical results show notable differences: in the pre-crisis period, monetary policy and exchange rate shocks significantly affect the output, price, money, interest rate and exchange rate, while, in the post-crisis period, only the money shock tends to have stronger influence on output. Moreover, the domestic monetary policy appear to be far more vulnerable to foreign shocks especially the world commodity price shock and output shock in the post-crisis than in the pre-crisis period. The findings clearly indicate that the crisis has changed the role of the monetary transmission channels in propagating various policy shocks to the real sectors of the Malaysian economy.
... However, this is not a debate limited to small or developing economies, as the empirical debate as to the appropriate role of the US Federal Reserve in muting the 1974 oil price shock shows; see Bernanke, Gertler and Watson (1997) and Hamilton and Herrera (2001). In this paper I examine the influence of external conditions on the Australian economy in the 1990s using an updated version of the structural VAR model given in Dungey and Pagan (2000). This model uses the US economy as the proxy for external conditions. ...
... Domestic shocks continued to impact negatively on growth in the mid-1980s, so that the slowdown in 1986 was due to a lower positive contribution from international factors than previous years. This is consistent with the definition of the terms of trade as an international shock, and if the decomposition is further refined the 1986 slowdown is clearly associated with the terms of trade (see for example figure 23 in Dungey and Pagan (2000)). In the late 1980s and early 1990 domestic factors were the driving force for the higher than trend GDP, while international factors were acting against this trend. ...
In the presence of large international disturbances small open economies are faced with difficult policy choices. International conditions impact on domestic outcomes. Using a structural VAR model of the Australian economy I explore the ways in which domestic monetary policy contributes to the output outcomes experienced in the economy. The focus is on the impact of international shocks. Monetary policy is modelled using a cash rate response to GNE, inflation and real exchange rate shocks. The results show that removing the focus on either GNE or inflation leads to lower GDP outcomes for the economy. The challenge for domestic policy is to recognise and respond to international and domestic shocks to the maximum benefit of the domestic economy.
... However, there is no unison on the number of variables essential in any given VAR model to provide a credible analysis of the economy. In a study by Dungey and Pagan (2000) their VAR model had 11 variables, whilst in another study by Kim and Roubini (2000) the authors discuss that seven variables are enough. Rafiq et al. (2009), suggests that most of these variables are appropriate for summarising the relevant dynamics in the macro economy. ...
This paper investigates the link between oil price uncertainty shocks and key macroeconomic indicators of a net oil importing country, South Africa. Monthly data covering the period 1990:01 to 2015:12 is used. The Structural Vector Autoregressive (SVAR) methodology is applied incorporating realized volatility as an indicator of oil price uncertainty to investigate the short run effects of oil price uncertainty. The Generalised Impulse Response Functions (GIRF) analysis reveals that for most variables, oil price uncertainty shock has an adverse and persistent effect over time. Consistent with GIRF, the Generalised Forecast Error Variance Decompositions (GFEVDs) analysis also points out that oil price uncertainty shocks contributes substantially to variations in real output, inflation and various macroeconomic variables of South Africa. Therefore, SVAR analysis reveals the significant role of exogenous oil prices on the economy of South Africa when price uncertainty shocks exist. The policy implications of these findings are drawn.
... This implies that domestic block contemporaneously responds to the foreign block, but not other way around, the restrictions are also imposed on the lagged values of domestic block, owing to the fact that small economy has no influence on world economy. The order of foreign block to lead domestic block has been guided by the prior literature on SVAR modeling for small open economy (Cushman & Zha 1997; Dungey & Fry 2000; Dungey & Pagan 2000; Perera, & Wickramanayake 2013;). The inclusion of world commodity prices (WCP) ahead of federal funds rate (FFR) is in line with Kim & Roubini (2000), that US monetary policy response to inflationary pressure due to negative supply shock. ...
The objective of this study is to investigate the relative importance of four transmission channels (i.e. interest rate, credit, exchange rate and asset price channel) of monetary policy in achieving the internal balance for a small open-economy of Pakistan. This study has employed open-economy Structural vector autoregressive (SVAR) model with non-recursive identification. This method is undertaken to analyze the effects of external shocks on the domestic macroeconomic variables and on domestic monetary policy. The shutdown method in SVAR has also been used to gauge the relative importance of each channel. The results show that foreign shocks have contractionary effects on domestic economy and monetary policy. Interest rate channel has been less important on inflation rate than asset price and credit channel, although it is found important in output variations. Exchange rate channel has been found least important in both cases of inflation and output in Pakistan. This study has found that central bank of Pakistan can only utilize interest rate channel when it targets output, whereas to control inflation rate the asset price channel is relatively more useful.
... The vector auto regression (VAR) model has been widely used to analyze the transmission mechanism of macroeconomic policies after Sims (1980). So far, several studies (such as Dungey & Pagan 2000 Dungey and Fry 2010) have used VAR approach in analyzing the effects of macroeconomic shocks on the Australian economy. However, no attention was given in analyzing the effects on the labour market in their studies. ...
... Moving average errors are introduced which, with 75 observations suggest two or three lags might suffice. Clearly this model is at the limits of what can reasonably be estimated with 75 observations, but similar in size 13 to some models which have been estimated (Dungey and Pagan, 2000). An AIC was used to select the lag length on each replication with a maximum of three in the 10-equation d.g.p. and the same lag length was used for all of the estimated models. ...
It is common to include both time series that exhibit drift and those that do not in macroeconomic forecasting models. In such situations, each equation in a VEC has a constant term that depends upon all of the drift parameters, and all of the coefficients on the lagged variables, so that no linear restrictions can be imposed to ensure that the relevant subset of variables do not exhibit drift in the forecast period. A Bewley (1979) transformation is proposed to enable the drift parameters to be directly estimated and, hence, restricted. Both exact restrictions and Bayesian methods are compared in a Monte Carlo forecasting comparison and an empirical example. The new estimator is found to have considerable advantages over standard VARs, BVARs, VARs in differences (DVARs), and simple linear detrending methods prior to estimating VARs and DVARs, in the mixed drift case.
... GNE represents domestic absorption following Pagan (2000, 2009) as a better measure of aggregate demand in a small open economy. The inclusion of GNE and GDP in the same SVAR model is similar to Dungey and Pagan (2000). The log of GNE minus the log of GDP is approximately equal to the trade balance. ...
This paper empirically presents monetary and fiscal policy interactions in Thailand's Struc-tural Vector Error Correction Model (SVECM) setting up based on a theoretical Dynamic Stochastic General Equilibrium (DSGE) model. The theoretical model suggests a minimum set of variables in a SVECM and provides some useful information to impose short-run and long-run restrictions. The SVECM can quantify the impacts and consequences of key macroeco-nomic variables for the Thai economy in response to a variety of shocks using impulse response functions and historical decompositions. The results show that the DSGE-SVECM set up can be supported by the Thai data.
... We also adopt a VAR framework, but depart from the standard approach in allowing the response of domestic variables to vary depending on the nature of the terms of trade shock. Liu (2010) also examines the effect of different types of international shocks on the Australian economy but like Dungey and Pagan (2000 Pagan ( , 2009), Liu assumes that terms of trade shocks do not influence foreign variables. In contrast, we maintain the small open economy assumption that the prices of tradeable goods are determined in world markets, implying that all terms of trade shocks originate in (and affect) the world economy. ...
This article describes and quantifies the macroeconomic effects of different types of terms of trade shocks and their propagation in the Australian economy. Three types of shocks are identified based on their impact on commodity prices, global manufactured prices and global economic activity. The first two shocks, a world demand shock and a commodity-market-specific shock, are fairly standard. The third shock, a globalisation shock that may result, for instance, from the increasing importance of China, India and eastern Europe in the global economy, is more novel. The globalisation shock is associated with a decline in manufactured prices, a rise in commodity prices and an increase in global economic activity.
Determining the underlying source of variation in the terms of trade is shown to be important for understanding the impact on the Australian economy as all three shocks propagate through the economy in different ways. The relative contribution of each shock to inflation, output, interest rates and the exchange rate has also varied over time. The main conclusion of the article is that a higher terms of trade tends to be expansionary but is not always inflationary. A key result is that the floating exchange rate has provided an important buffer to the external shocks that move the terms of trade.
... All empirical puzzles are absent in both studies. In Australian SVAR models, Brischetto and Voss (1999) and Dungey and Pagan (2000) obtain sensible results without monetary aggregates and oil prices that feature prominently in the literature. Brischetto and Voss adopt the Kim-Roubini identification scheme but find it necessary to include the foreign interest rate in the monetary policy equation; its exclusion yields a rise in output and prices, and an impact depreciation of the nominal exchange rate in the event of an unanticipated monetary tightening. ...
We estimate a SVAR for the Australian economy based on an open economy New Keynesian model. Deep structural parameters are identified by placing exclusion restrictions on the VAR residuals and the covariance matrix. Parameter estimates suggest that the New Keynesian specification fits Australian data well. Dynamic responses show no price and exchange rate puzzles and indicate that the Reserve Bank of Australia (RBA) has a short-run focus on stabilizing output fluctuations while maintaining a medium-run inflation target since 1984. The RBA responds decisively to aggregate demand and exchange rate shocks while passively allowing the economy to self-correct aggregate supply shock.
... " However, recent developments in this literature do include exogenous variables in the VAR (e.g. see Dungey and Pagan, 2000). The impact of an exogenous shock is measured by " impulse responses " in the VAR. ...
We study the effect of domestic policies and external shocks in a semi-open economy characterized by incomplete liberalization of the financial sector. We argue that in such transition economies stabilization programs can have a negative impact on the fiscal imbalances, offsetting to some extent the very achievement of the stabilization program. We develop a simple general equilibrium model which allows propagation of shocks in the presence of government guarantees and imperfect capital mobility. We also empirically test the impact of positive foreign interest shock on the Indian economy using a reduced form VAR approach. The econometric evidence, though broadly consistent with the main predictions of the model, suggests no significant impact of foreign interest rate shock on output and credit. We conclude that incomplete liberalization of the financial sector in transition economies has two effects. It reduces i) exposure to external financial shocks (like the current credit crisis) and ii) ability to deal with real sector shocks (which may arise from global recession in the medium term) due to endogenous policy reversals and presence of government guarantees.
... In addition to this standard framework, the role of wealth effects through the equity markets are explicitly recognised by the inclusion of the so-called Q-ratio variables, which represent specifically the ratio of the US S&P500 to the US CPI ( * ) and the ASX200 to the Implicit Price deflator for machinery and equipment in Australia ( ). These two variables provide a direct representation of the role of investment in the economy, and were shown in Dungey and Pagan (2000) to improve model performance and were a key feature of Fry, Hocking and Martin (2008) in another SVAR for Australia focussing on wealth effects. The exchange rate equation in a NK specification represents the UIP relationship. ...
Monetary and fiscal policy actions are designed to influence eco-nomic outcomes. Their interactions may have important, and some-times contradictory, impacts. This paper incorporates fiscal and mon-etary policy shocks into a small open economy SVAR model of the Australian economy, incorporating identification by combining sign restrictions, exclusion restrictions and cointegration, while directly recognising the mixed non-stationary and stationary nature of the rel-evant variables. The results over the period to 2006 show the impact of government expenditure and revenue shocks on output and debt particularly, indicating the changes in interest rates occuring in re-sponse to fiscal policy shocks. Contractionary monetary policy shocks result in reduced government revenue, but are also associated with re-duced debt to GDP ratios. Ongoing work examines the contribution of policy responses to the behaviour of this economy during the Global Financial crisis.
... Ultimately we aim to use a combination of the sign restriction methodology to identify the fiscal shocks following the methods proposed in Fry and Pagan (2007), and the distinction between temporary and permanent shocks in cointegrating data proposed in Pagan and Pesaran (2007) to incorporate the properties of the data in the system as in contemporaneous work in Dungey and Pagan (2007). This will allow us to both account for the difficulties in identifying fiscal shocks and account for the mixed I(1) and I(0) variables in the same system. ...
This paper begins the process of constructing a VAR model for a small open economy, in this case New Zealand, to assess the empirical effects of both fiscal and monetary policy shocks on major macroeconomic indicators. Fiscal policy is represented by government expenditure and government revenue shocks, and monetary policy via the short term interest rate. The innovations in the model are in using the sign restriction methodology for fiscal policy shocks within a more traditionally identified VAR for the remainder of the system, and in accounting for transitory and permanent components in the series as in Pagan and Pesaran (2007). This paper reports on the first stage of this process, the identification of the fiscal policy shocks as a base on which the remainder of the project will be built.
... Kim and Roubini stress that if false restrictions are imposed, the resulting inferences would be incorrect as well. Other studies that have followed this approach of estimating structural VARs in levels even when the variables are I(1) include Piffanelli (2001), Dungey and Pagan (2000), Kim (1999, Brischetto and Voss (1999), Bernanke and Mihov (1998), Ramaswamy and Sloek (1998), and Sims (1992), among many others. Some studies, however, have opted to transform non-stationary data prior to estimating structural VARs. ...
This paper sets out to investigate the process through which monetary policy affects economic activity in Malawi. Using innovation accounting in a structural vector autoregressive model, it is established that monetary authorities in Malawi employ hybrid operating procedures and pursue both price stability and high growth and employment objectives. Two operating targets of monetary policy are identified, viz., bank rate and reserve money, and it is demonstrated that the former is a more effective measure of monetary policy than the latter. The study also illustrates that bank lending, exchange rates and aggregate money supply contain important additional information in the transmission process of monetary policy shocks in Malawi. Furthermore, it is shown that the floatation of the Malawi Kwacha in February 1994 had considerable effects on the country's monetary transmission process. In the post-1994 period, the role of exchange rates became more conspicuous than before although its impact was weakened, and the importance of aggregate money supply and bank lending in transmitting monetary policy impulses was enhanced. Overall, the monetary transmission process evolved from a weak, blurred process to a somewhat strong, less ambiguous mechanism.
... (However, initially consumer prices of imported goods do not fall as much as domestically produced goods which makes imported goods initially relatively more expensive .) The peak response of (annualised) inflation to the unit shock to the interest rate is a imum response of inflation to a monetary policy shock is faster than that which is found in some other studies, including those employing structural VARs (see, for instance, Dungey and Pagan 2000; Berkelmans 2005). Some of this difference may be explained by the relatively stringent restrictions imposed by the structural model compared with an SVAR. ...
This paper sets up and estimates a structural model of Australia as a small open economy using Bayesian techniques. Unlike other recent studies, the paper shows that a small micro-founded model can capture the open economy dimensions quite well. Specifically, the model attributes a substantial fraction of the volatility of domestic output and inflation to foreign disturbances, close to what is suggested by unrestricted VAR studies. The paper also investigates the effects of various exogenous shocks on the Australian economy.
... A sizeable share of this appears to be due to foreign monetary policy innovations, although this may, in part, reflect factors that are outside of the model, such as global confidence , that are transmitted to the domestic economy via international financial markets. This view is consistent with the findings in Dungey and Pagan (2000), which shows that international financial linkages are important when modelling the Australian economy. At the longer forecasting horizon, all three foreign factors maintain their influence on domestic output gap variations with both the foreign interest rate and foreign output remaining the dominant contributors. ...
This article examines the sources of Australia's business cycle fluctuations. The cyclical component of gross domestic product is extracted using the Beveridge–Nelson decomposition and a structural Vector autoregressive model (VAR) model is identified using robust sign restrictions derived from a structural small open economy model. In contrast to previous VAR studies, international factors are found to contribute to over half of the output forecast errors whereas demand shocks have relatively modest effects.
... The appropriate choice of detrending procedure is not straightforward. A linear deterministic trend has been the preferred method for several recent Australian structural VAR models (Dungey and Pagan, 2000;Dungey and Fry, 2003). This procedure is appropriate if the aim is to avoid removing the stochastic trend component from the growth cycle. ...
New Zealand is a small economy exposed to a volatile climate, relatively volatile international trade prices, and its exposure to international financial markets has increased markedly since economic reforms in the 1980s. This paper applies identification techniques suggested by Cushman and Zha [Cushman, D.O. and Zha T.A., 1997. Identifying monetary policy in a small open economy under flexible exchange rates, Journal of Monetary Economics, 39, pp. 433–448.], Zha [Zha, T.A., (1999). Block recursion and structural vector autoregression, Journal of Econometrics, 90, pp. 291–316.] and Dungey and Pagan [Dungey, M. and Pagan, A., 2000. A structural VAR model of the Australian economy, The Economic Record, 76, pp. 321–342.] to develop a large four block structural VAR model of the New Zealand business cycle to capture these features. The model reveals that climate and international trade price shocks have been more important sources of business cycles fluctuations than international or domestic financial shocks. Furthermore, the model does not encounter the price and exchange rate puzzles that have bedevilled attempts to identify monetary policy shocks in small open economy SVAR models.
... Huh (1999) based the identifying assumptions on a static Mundell–Fleming model with impositions of short-run and long-run restrictions. Dungey and Pagan (2000, 2009) developed a block-recursive structural model with eleven variables. This article presents a New Keynesian SVAR model of the Australian economy where the identification scheme is based on a small open economy New Keynesian model that specifies the interactions between the exogenous structural shocks and the forward-looking behaviour exhibited by economic agents. ...
We estimate an SVAR model for the Australian economy based on an open economy New Keynesian model that accounts for the forward-looking behaviour exhibited by economic agents. Deep structural parameters are identified by placing exclusion restrictions on the VAR residuals and the covariance matrix. Dynamic responses show no price and exchange rate puzzles and indicate that the Reserve Bank of Australia (RBA) stabilises output fluctuations in the short run while maintaining a medium-run inflation target since 1984. Aggregate demand shocks are found to be driven by external demands. The RBA exercises caution in responding to aggregate supply shocks.
... Although the 20 years that have elapsed since the pioneering days of VAR modelling produced significantly longer time series, the need for methods such as BVARs to reduce the demands of modelling on data have not diminished. Researchers have begun to develop larger models (Dungey and Pagan, 1999) and structural changes often prevent older data being used. Recently, Abadir, Hadri and Tzvalis (1999) demonstrated that the bias in parameter estimates of VARs with I(1) data increases with the inclusion of extraneous I(1) variables. ...
A Bayesian vector autoregression (BVAR) can be thought of either as a method of alleviating the burden of the over-parameterisation usually associated with unrestricted VARs, or as a method of correcting coefficient bias when the time series are nonstationary. Monte Carlo evidence is provided to show that the latter appears to be a more important characteristic of BVARs in experiments using a 4-equation cointegrated system, and with that system embedded in a 10-equation model containing six extraneous random walks. It is found that the BVAR model generally performs much better than a VAR in levels and is a viable alternative to a vector error correction model. It is also found that estimating constant terms when there is no drift in the data causes a major deterioration in forecasting performance.
... Australian VAR research has also continued this tradition, as seen in the work by Smith and Murphy (1994) and Dungey and Pagan (1997). The logic behind this ordering comes from the perceived short-run rigidity of prices and the role of inventories in facilitating a de-coupling of prices and output in the short run. ...
In this paper we discuss the development of Phillips curves in Australia over the forty years since Phillips first estimated one using Australian data. We examine the central issues faced by researchers estimating Australian Phillips curves. These include the distinction between the short- and long-run trade-offs between inflation and unemployment, and the changing level of the non-accelerating inflation rate of unemployment (NAIRU), particularly in the 1970s. We estimate Phillips curves for prices and unit labour costs in Australia over the past three decades. These Phillips curves allow the NAIRU to change through time, and include a role for import prices and `speed-limit’ effects. The paper concludes by discussing the changing role of the Phillips curve in the intellectual framework used to analyse inflation within the Reserve Bank of Australia over the past three decades.
... To do this, we implicitly assume that policy shocks originate as pure shocks in the interest rate, which means isolating the feedback effects from the economy to these variables. Such an approach has been previously undertaken in Pagan (2000) and Buckle et al (2007). Here the same logic is applied to government expenditure, taxation and debt to GDP shocks which in combination result in a total fiscal policy indicator. ...
Good economic management depends on understanding shocks from monetary policy, fiscal policy and other sources affecting the economy and their subsequent interactions. This paper presents a new methodology to disentangle such shocks in a structural VAR framework. The method combines identification via sign restrictions, cointegration and traditional exclusion restrictions within a system which explicitly models stationary and non-stationary variables and accounts for both permanent and temporary shocks. The usefulness of the approach is demonstrated on a small open economy where policy makers are actively considering the interaction between monetary and fiscal policies.
The economy of Bangladesh is experiencing sustained economic growth. Thus, the purpose of this study is to analyze how human capital and material, or physical capital interact to influence the economic growth of Bangladesh. As a response to analyzing mechanisms of economic growth from 2000 to 2019, the present paper conducts quantitative research into the link between human capital, material capital, and economic growth in Bangladesh with the use of a Vector Autoregression Model (VAR). The study discovered that both human capital and physical capital can contribute to economic growth in different time dimensions, but their respective efficiency varies. As a result of the research, recommendations are made for policy development.
This paper employs the structural vector autoregression (SVAR) model to examine the change in fiscal policy stance (fiscal impulse) of a small open economy-Nigeria. The study further investigates how the economy dynamically responds to domestic shocks. Identification conditions were established to uncover the dynamic effects of fiscal impulse on various domestic variables. Restrictions based on economic theory are placed on the models so that the SVAR can be identified in the short run. The Impulse response functions (IRFs) and variance decompositions (VDCs) were also employed to examine the dynamic responses of the variables to various shocks within the SVAR system. Using quarterly data from 1970:q1 to 2008:q4, a five-variable SVAR model is established to study the shocks. The empirical results show that fiscal impulse has a significant positive effect on real output, money supply, and exchange rate contemporaneously, whereas the impact of fiscal impulse on inflation rate is negative, however, it is significant. The impulse responses of money supply, inflation, real output, and exchange rate with respect to the identified shocks (innovations) are consistent with the results of variance decomposition analysis. Hence, the study recommends that there is need for sound monetary, exchange rate and macroeconomic policies that will help manage shocks emanating from both internal and external sectors which influence the stance of fiscal policy in Nigeria. JEL Classification: H62, H87, C22.
This paper examines the relative importance of Singapore, US and Japanese macroeconomic shocks on Malaysian economy. Employing structural vector auto regression (SVAR) model with a sign restriction approach, the study estimates four models. Each model consists of four domestic macroeconomic variables (output, inflation, interest rate and exchange rate) and three foreign variables (output, inflation and interest rate) of US, Japan, Singapore and the all countries trade-weighted variables, respectively. The results of the study reveal that, relative to domestic shocks, foreign shocks appear to play more prominent role in influencing domestic macroeconomic variables. Among the three foreign countries being investigated, the effect of shock of Singapore is the most dominant. The US effect comes second and the Japanese effect comes last. When Singapore's variables are the only foreign factors in the system, their shocks bring about significant variation to Malaysian variables especially the output. Consequently, in modeling the effect of foreign factors on Malaysian economy, Singapore effect should be taken into account. This is important as Singapore is not only one of Malaysia's long-term major trading partners, but it is also one of the Malaysia's closest neighbors by geographical distance.
In this article we use a structural vector autoregression (VAR) model to analyse the possibilities of monetary and fiscal policy in achieving main economic policy goals, namely price stability and economic growth, in Croatia from 2004 to 2012. Our main results indicate that expansionary monetary and fiscal policies both have positive effects on economic activity. On the other hand, fiscal expansion leads to nominal exchange rate appreciation while monetary expansion has depreciation effects on nominal exchange rate. Thus the main conclusion of the article is that coordinated measures of monetary and fiscal policies could achieve both goals, i.e. that fiscal and monetary authorities can stimulate economic growth without endangering price stability.
We use a structural vector autoregression to examine the impacts of monetary policy in Croatia for 1998 – 2012. We explore the effects of interest and exchange rate transmission channels on the economy's response to the monetary shocks. We find that the impulse responses of output and prices to interest rate and exchange rate shocks follow predicted theoretical dynamics. We find the exchange rate channel has the largest impact on the real economy, while the interest rate channel has a limited role in transmitting monetary shocks to the economy. Future developments of monetary policy channels in Croatia are also discussed.
This paper employs Vector Autoregressive (VAR) and Structural VAR (SVAR) models to analyse
Vietnam’s inflation determinants using quarterly data from 1996 to 2012. The results suggest that:
(i) the inflation responses to monetary policy shocks are plausible and similar to standard
monetary transmission in advanced economies; (ii) the policy interest rate plays an important role
to inflation variation, which differs with what have been found in previous studies for Vietnam; and
(iii) shocks to output and prices in trading partners have strong effects on inflation in Vietnam,
while international oil and rice prices seem not to systematically affect Vietnam’s inflation.
Moreover, the State Bank of Vietnam does use monetary policy tools to ease down the
inflationary pressure caused by foreign factors.
This paper examines the relative importance of various financial and real shocks underlying oil price fluctuations using alternative Bayesian VAR approaches to calibrate the nature of major shocks. With a view to understanding the time-varying nature of shocks and structural shifts in their persistence, the models are estimated for two sub-periods. Contrary to some empirical findings, we find limited support for the argument that monetary policy shocks played an important role in causing fluctuations in oil prices. We also find evidence of significant but short-run effect of supply shocks on oil prices, whereas demand shocks seem to play a major role in driving oil prices in the medium to long-run. Precautionary oil demand shocks including speculation in commodity markets seem to have strong short-run impact on oil prices. Contrary to the belief held by some, demand shocks have now emerged as key drivers of oil prices over the medium to long-run. The findings do not, however, completely ignore the indirect role played by financial factors including short-term interest rates in causing fluctuations in oil prices by way of stimulating aggregate demand.
The paper is essentially in three parts. (A) First it outlines and documents the labour market framework in TRYM and attempts to validate the framework by showing how it can explain certain historical facts such as why unemployment is now much more cyclical than in the 1960s. To further validate the framework, it is compared and reconciled with the labour market specifications in a recent paper by the RBA (Debelle and Vickery 1998). (B) The paper then turns to some of the implications of the framework and what it says about the linkages between wages and unemployment. An important aspect of how a wage change impacts on unemployment under our current monetary policy framework is via the interest rate reaction to the inflation generated by higher nominal wages. The paper therefore compares the monetary policy response in TRYM with that in other Australian macro models. It then looks at the full model response to a wage shock and demonstrates that the interest rate reaction is important in generating the short-term employment response. (C) The paper then looks at the macroeconomic consequences of reducing unemployment, including implications for living standards and macroeconomic aggregates such as national saving and investment. Inter alia the paper touches on what the model has to say about the sources of the increase in unemployment in the 1980s and 1990s. While it is impossible to be precise, the evidence from the model suggests that the observed increase in structural unemployment was only partly due to search effectiveness factors. It seems macroeconomic wage setting and price setting factors (eg institutional/bargaining factors, the fall in productivity growth, decline in the terms of trade, and perverse feedback such as to taxation and to the cyclicality of unemployment itself) played an important role in explaining the level and persistence of unemployment in the late 1980s early 1990s.
Economic events such as expansions and recessions in economic activity, bull and bear markets in stock prices and financial crises have long attracted substantial interest. In recent times there has been a focus upon predicting the events and constructing Early Warning Systems of them. Econometric analysis of such recurrent events is however in its infancy. One can represent the events as a set of binary indicators. However they are different to the binary random variables studied in micro-econometrics, being constructed from some (possibly) continuous data. The lecture discusses what difference this makes to their econometric analysis. It sets out a framework which deals with how the binary variables are constructed, what an appropriate estimation procedure would be, and the implications for the prediction of them. An example based on Turkish business cycles is used throughout the lecture.
This paper introduces the Financial Macro-econometric Model (FMM) being developed by the Bank of Japan. The FMM is a medium-sized structural model comprising two sectors: a financial sector and a macroeconomic sector. It permits the quantitative analysis of various phenomena created by the feedback loop between the financial economy and the real economy. The model's most distinctive feature, which is rarely observed in this type of model, is seen in the financial sector, where we model the actual risk management behavior of banks. It facilitates macro stress testing and allows the robustness of the financial system and its effects on the macro economy to be consistently verified from various perspectives.
This paper examines the ability of vector autoregressive (VAR) models to properly identify the transmission of monetary policy in a controlled experiment. Simulating data from an estimated small open economy DSGE model for Australia, we find that sign-restricted VAR models do reasonably well at estimating the responses of macroeconomic variables to monetary policy shocks. This is in contrast to models that use recursive zero-type restrictions, for which inflation can rise following an unexpected interest rate increase while the exchange rate can appreciate or depreciate depending on the ordering of the variables. However, central tendency measures of sign-restricted VAR models can be misleading and hardly ever coincide with the true impulses. This finding casts doubt on the common notion that the median impulses are the ‘most probable’ description of the true data generating process. Finally, the paper presents some results from a sign-restricted VAR model estimated using Australian data.
Fraser P., MacDonald G. A. and Mullineux A. W. Regional monetary policy: an Australian perspective, Regional Studies. A structural vector autoregressive (SVAR) model for Australia is utilized to identify the domestic impacts of common monetary policy shocks on national and state business cycles and to consider the role of state diversification disparities for observed differences in responses to monetary policy innovations. Western Australia and Queensland differ to other states in their response to common shocks and evidence suggests this may be due to differences in their economic geographies. Overall, the Australian monetary union has become increasingly reliant on fiscal transfers particularly from Western Australia in the past two decades. This emphasizes the importance of a political union underpinning a successful monetary union.
After marked fluctuations in the business cycle over the last fifty
years, the Chilean economy now appears to be less volatile and more
resilient to external shocks. Because Chile is a small and increasingly
open economy, analysts have long suspected that the amplitude of the
cyclical fluctuations in the business cycle is closely related to changes
in external conditions.
However, many open questions remain in this regard. To what
extent are the pronounced output fluctuations associated with ups
and downs in external conditions, and to what extent can they be
attributed to domestic sources? Are real or financial external shocks
the most important source of fluctuations? Has the increasing
international integration implied greater synchronization of the domestic cycle with external economic conditions? If so, does this imply greater external vulnerability, or has resilience to external shocks
improved somewhat?
To address these questions, we adopt an empirical approach
using a vector autoregressive (VAR) model with block exogeneity.
We adapt the VAR model to the behavior of a small open economy
and then use it to characterize and decompose the behavior of the
Chilean business cycle. Since our model includes a comprehensive
set of variables, we can evaluate the importance of external, policy,
and other domestic variables for the business cycle. We are thus
able to assess how the economy has responded to different stochastic
disturbances, measure the contribution of these variables to the
business cycle fluctuations, and analyze the resilience of the Chilean
economy over the last half century.
Several interesting results emerge from this analysis. First, real
and financial external shocks have significant effects on domestic
economic activity. The significant impact on the cyclical behavior of
the economy following external financial shocks (represented by the
volatility of the international financial markets and net capital inflows)
reflects the financial restrictions faced by an emerging economy like
Chile. Among domestic policy shocks, demand management policies
and structural policies affect business cycle fluctuations, as do other
domestic shocks such as investors confidence. Altogether, however,
foreign shocks have been the dominant source of domestic output
fluctuations, followed by monetary policy and structural policies. Fiscal
policy and domestic equity explain a relatively low fraction of the
volatility of the business cycle. Second, we provide evidence of an
increase in the Chilean economy’s resilience to external shocks in the
1990s. This positive development has taken place even as the economy’s deepening integration with the rest of the world has increased the synchronization of the domestic business cycle with international conditions. This trend underscores the significant countercyclical role played by policies.
This paper establishes vector autoregressive moving average (VARMA) models for Malaysian monetary policy analysis by efficiently identifying and simultaneously estimating the model parameters using full information maximum likelihood. The monetary literature is largely dominated by vector autoregressive (VAR) and structural vector autoregressive (SVAR).models, and to the best of our knowledge, this is the first paper to use VARMA modelling to investigate monetary policy. Malaysia is an interesting small open economy to study because of the capital control measures imposed by the government following the 1997 Asian financial crisis. A comparison of the impulse responses generated by these three models for the pre- and post-crisis periods indicates that the VARMA model impulse responses are consistent with prior expectations based on economic theories and policies pursued by the Malaysian government, particularly in the post-crisis period. Furthermore, uncovering the way in which various intermediate channels work would help Bank Negara Malaysia to steer the economy in the right direction so that monetary policy can still remain an effective policy measure in achieving sustainable economic growth and price stability.
The role played by macroeconomic fluctuations in stimulating deposit dollarization in developing countries have been a subject of intense debate in the last few decades especially in Latin America and transition economies of Eastern Europe with little attention on African economies. Apart from this, most of the studies on African economies are country case studies with little scope for generalisation. This article examines the effect of macroeconomic fluctuations on deposit dollarization in 18 selected Sub-Saharan Africa for the period 1980 to 2004. Using the standard money demand model accounting for dollarization in small open economies, the article finds that inflation, expectations about exchange rate changes coupled with interaction between capital account restrictions and domestic inflation plays dominant roles in explaining deposit dollarization in Sub-Sahara Africa. Given the consequences of deposit dollarization on the vulnerability of the domestic banking system, lack of independent monetary policy and optimal exchange rate choices, the article concludes that macroeconomic instability must be adequately brought under control in other to reduce deposit dollarization in these economies.
The objective of the structural VAR model developed in this paper is to identify the effects of Australian monetary policy on the economy, within a small open economy framework. The methodology applied is the Bayesian techniques of Sims and Zha (1998) and Waggoner and Zha (2000) to incorporate prior information into the VAR model. Results consistent with economic theory are achieved by employing a block exogeneity assumption combined with additional contemporaneous and lagged linear restrictions. The paper examines the effects of introducing a mark-up pricing model restriction in to the monetary policy environment. In summary, the effects of restricting the model with this assumption, in comparison to the base model, is to lengthen the negative output gap produced by a wage inflation shock. Conversely, a price inflation shock induces a relatively larger fall in real wages that subsequently leads to a more pronounced above trend phase in output. The effect of a cash rate increase in the mark-up restricted model is to have a very similar effect on reducing the level of GDP to the unrestricted case.
In response to monetary policy shocks, the market yield curve has been observed to shift or rotate. We use detailed data on the history of monetary policy changes in Australia, Canada, and New Zealand as an identification scheme in a latent factor model on daily term structure data. We demonstrate that the differing yield curve responses to unanticipated changes in monetary policy may reflect reactions to different types of monetary policy shock rather than differing reactions to the same policy shock. These different responses have recently been hypothesized to reflect information asymmetries between the monetary authority and other market participants.
A growing literature has documented changes to the dynamics of key macroeconomic variables in industrialized countries and highlighted the possibility that these variables may react differently to structural shocks over time. However, existing empirical work on the international transmission of shocks largely abstracts from the possibility of changes to the international transmission mechanism across time. In addition, the literature has largely employed small-scale models with limited number of variables. This paper introduces an empirical model which allows the estimation of time-varying response of a large set of domestic variables to foreign money supply, demand and supply shocks. The key results show that a foreign monetary policy tightening resembles the classic beggar-thy-neighbour scenario for the United Kingdom in the period 1975-90. In more recent periods, the response is negative but largely insignificant.
We estimate a new Keynesian open economy dynamic stochastic general equilibrium model of Australia with a large number of shocks, frictions and rigidities, matching a large number of observable time series. We find that both foreign and domestic shocks are important drivers of the Australian business cycle. We also find that the initial impact on inflation of an increase in demand for Australian commodities is negative, because of an improvement in the real exchange rate, although there is a persistent positive effect on inflation that dominates at longer horizons.
A structural vector autoregression model is used to identify overvaluation in house prices in Australia from 2002 to 2008. An important feature is the development of a housing sector where long-run restrictions are derived from theory to identify housing demand and supply shocks. The results show strong evidence of overvaluation in real house prices, reaching a peak of just over 15 per cent by the end of 2003. Factors driving overvaluation are housing demand shocks before 2006 and post‐2006 macroeconomic shocks. Wealth effects from equity markets are also important. The results suggest that monetary policy is not an important contributor to overvaluation of house prices.
The purpose of this paper is to assess the relative impact of the US and Japanese business cycles on the Australian economy. Our vector autoregression (VAR) models include real gross domestic products (GDPs) of three countries and world average oil price, which are quarterly covering the period 1959:3–1996:4. In order to take account of a possible structural change, estimates are also made separately for the fixed exchange rate and flexible exchange rate periods. The rolling regression technique is utilised to trace the patterns and extents of changing importance between the US and Japan’s impacts on the Australian economy. We find that over the entire sample period, the business cycles of both the US and Japan have the significant impacts on movements in Australian GDP. Under the recent flexible exchange rates, however, the impact of US output becomes greater, while the Japanese impact becomes smaller and negative. It also appears that US output has significant impacts in both short and longer term, while Japanese output has little impact in the short term, but greater impact in the longer term.
Recent empirical work on the Phillips curve has focused on the convexity of the relationship between inflation and unemployment. In this paper we argue that another potentially important source of nonlinearity in the Phillips curve is to be found in asymmetric price adjustment. If prices rise more easily than they fall, then a threshold autoregressive specification seems a natural framework within which to re-examine the Phillips curve. We examine the Australian data used by a recent article on the Phillips curve and show that there are significant asymmetries in inflation, the Phillips curve and in the behavior of unit labor costs.
Innovations state space time series models that encapsulate the exponential smoothing methodology have been shown to be an accurate forecasting tool. These models for the first time are applied to Australian macroeconomic data. In addition new multivariate specifications are outlined and demonstrated to be accurate.
This paper aims at investigating business cycle interdependences among Mercosur countries over the period 1991-2006. In particular, it analyses the causation relationships among the aforementioned countries’ business cycles, and the impact of the EU and US shocks on them. The estimated VAR model points out that some causation relations are present among the former, and that, conversely, the latter do not play a relevant role in determining the fluctuations of their economies.
Forecasting models for output are presented to throw light on monetary transmission. Recent research finds multistep forecasting superior to recursive forecasting from a VAR model when structural breaks are present; there are important political and policy regime breaks in South Africa. The equilibrium correction models have a four-quarter ahead forecast horizon, appropriate for measuring interest rate effects. A stochastic trend measures underlying shifts in productivity and other supply side trends. The inclusion of important monetary policy regime shifts, which altered the output response to interest rates, and the control for other structural changes (e.g., trade liberalization), address the Lucas critique in forecasting output growth. There are important and persistent effects of high real interest rates, which significantly constrained growth in the 1990s, and significant potential growth benefits from fiscal discipline. South African growth appears to have become more responsive to the exchange rate with increasing trade openness in the 1990s.
Primero, este trabajo presenta una revisión de los principales estudios con VAR monetarios en Chile y en el mundo para medir la política monetaria y el traspaso del tipo de cambio a precios (pass-through). Segundo, se estiman tres VAR estructurales con restricciones de corto plazo y un VEC con restricciones de largo plazo. Los resultados indican que la transmisión monetaria es menos efectiva en los últimos años que en el período 1986-1997 y que el bajo pass-through depende de la actividad, la inflación y la meta de inflación.
Models of Australia proxy international linkages using the US, despite Japan being an equivalent
trading partner. This paper uses a Kahnan filter to extract US and Japanese reference cycles
which are then used in an SVAR model of the Australian economy. The US and Japanese shocks
are interpreted to be aggregate demand and interest rate shocks respectively. The results show
that US shocks axe dominant for Australian outcomes, but the model is misspecified if Japan is
excluded. The role of Japan is to dampen expansionary US shocks. Further, Australian monetary
policy responds to domestic conditions, rather than international monetary policy.
Long-term nominal interest rates in a number of inflation-targeting small open economies have tended to be highly correlated with those of the United States. This observation has recently lent support to the view that the long end of the yield curve is determined abroad. We set up and estimate a micro-founded two-block small open economy model to study the co-movement of long-term nominal interest rates of different currencies. The expectations hypothesis together with uncovered interest rate parity, which both hold in our model, can account for much of the co-movement of interest rates observed in the data.
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