International transmission of shocks:

Transcription

1 Inernaional ransmission of shocks: A ime-varying FAVAR approach o he Open Economy Philip Liu Haroon Mumaz Moneary Analysis Cener for Cenral Banking Sudies Bank of England Bank of England CEF 9 (Sydney) 7 July 9 Absrac A growing lieraure has documened changes o he dynamics of key macroeconomic variables in indusrialized counries and highlighed he possibiliy ha hese variables may reac differenly o srucural shocks over ime. This paper inroduces an empirical model which allows he esimaion of ime-varying response of a large se of domesic variables o foreign money supply, demand and supply shocks. The views expressed in his work are hose of he auhors, and do no necessarily reflec hose of he Bank of England. philip.liu@bankofengland.co.uk and haroon.mumaz@bankofengland.co.uk.

2 Moivaion Wha we do in he paper: Exends he open economy FAVAR models o allow for ime variaions Examine possible changes o he ransmission of inernaional shocks: foreign moneary policy, demand and supply The model capures he changing co-movemens among he macroeconomic ime series by allowing heir dependence on common facors o evolve over ime Also allows for sochasic volailiy in he innovaion process of he facors Inernaional ransmission of shocks, 7 July 9 Slide /4

3 More references included in he paper. Inernaional ransmission of shocks, 7 July 9 Slide /4 Liu and Mumaz Why is his ineresing or useful? Undersanding of he inernaional ransmission mechanism is an essenial ingredien for policy discussions Small-scale SVAR sudies ofen encouner many open economy anomalies Differen idenificaion schemes have had mixed successes Bernanke e al. (5) propose using FAVAR for srucural analysis o overcome limied informaion problem helps wih closed economy anomalies Boivin and Giannoni (8), and Mumaz and Surico (8) exend he FAVAR o open economy framework many of he open economy anomalies disappear The grea moderaion lieraure had documened significan fall in inflaion and oupu volailiy

4 Moreover, deec changes in he domesic ransmission mechanism Fix coefficien model esimaes only ell us he average of he pas Unsaisfacory o simply assume he size and he ransmission of inernaional shocks has no changed over his period Main conribuion of he paper: assess possible changes o he ransmission of world moneary policy, demand and supply shocks on he U.K. economy derive dynamic responses for a wider range of economic indicaors robus idenificaion: large daase and agnosic srucural idenificaion scheme Inernaional ransmission of shocks, 7 July 9 Slide 3/4

5 The small open economy FAVAR model Transiion equaion: F F UK R = B (L) B (L) B (L) B 3 (L) B 3 (L) B 3 (L) B 33 (L) F F UK R + u () The srucure of B(L) reflecs he small open economy assumpion such ha domesic facors does no impac on world facors, bu no he vice versa; and u = Ω / e, where Ω = A, (A, ). The ime-varying covariance marix of he VAR innovaions, u, can be facored as Var(u ) Ω = A H ( A ) () Inernaional ransmission of shocks, 7 July 9 Slide 4/4

6 Observaion equaion: X Y X π X R = X UK R Λ Y Λ π Λ R Λ UK Λ R F Y F π F R F UK R + v (3) v = ρ(l)v + ǫ (4) The srucure of Λ marix reflecs he facor idenificaion resricions. Noe:. he facor loading Λ is ime-varying (he naure of co-movemen changes over ), all TV coefficiens are assumed o follow RW. () and (3) are closely relaed o Canova and Ciccarelli s (6) large VAR We assume ha all real aciviy series in he foreign block of he model share a common dynamics and ha such common dynamics is no shared by any oher series in he panel. The domesic facors are no explicily idenified. Inernaional ransmission of shocks, 7 July 9 Slide 5/4

7 Esimaion - Muli-sep Gibbs sampling In sae-space form: F = B(L)F + e, where e N(, Ω ) and Ω = A ( ) H A (5) X = Λ F + v, where v = ρ(l)v + ǫ and ǫ N(, R) (6) Break he complex problem (sampling from he join poserior disribuion) ino a sequence of racable ones (sampling from he condiional disribuions), see Kim and Nelson (998) and Carer and Kohn (994) Quarerly daa from 974Q o 5Q which span 7 counries and 56 series Inernaional ransmission of shocks, 7 July 9 Slide 6/4

8 Inernaional co-movemens Figure : Sandardized foreign facors (ligh blue band is he 95% confidence inervals) World real aciviy World inflaion World ineres rae % CI Gibbs zero PC Inernaional ransmission of shocks, 7 July 9 Slide 7/4

9 A sylized view of he ransmission of MP* shock Foreign moneary expansion (R* falls) Appreciaion of serling (Q increases) UK aciviies (depend on ES/IE) Producer currency pricing PPP holds ToT improves as UK expors more expensive and impors are cheaper Expendiure swiching (ES) effec from UK o foreign goods Y* rises while Y falls Beggar-hy-neighbour scenario + Local currency pricing Imperfec ERPT PPP does no hold ToT improves by less because impors are no cheaper (priced in ) Less incenive for UK consumer o buy foreign goods Y* rises while Y may rise Posiive income effec (IE) from lower R* Inernaional ransmission of shocks, 7 July 9 Slide 8/4

10 An unanicipaed increase in world ineres raes varying IRF 4 Real Aciviy Inflaion World Ineres Rae Inernaional ransmission of shocks, 7 July 9 Slide 9/4

11 varying IRF 4 Accumulaed response: and 4 NEER Terms of rade Impor Prices Trade Balance Expor Prices Inernaional ransmission of shocks, 7 July 9 Slide /4

12 Invesmen varying IRF Accumulaed response: and 4 4 GDP Consumpion Inernaional ransmission of shocks, 7 July 9 Slide /4

13 varying IRF 4 Accumulaed response: and 4 CPI Inflaion Wages GDP Deflaor Inernaional ransmission of shocks, 7 July 9 Slide /4

14 House Prices FTSE yr Bond Shor erm rae varying IRF Accumulaed response: and Inernaional ransmission of shocks, 7 July 9 Slide 3/4

15 Concluding remarks Our resuls are robus o differen idenificaion scheme, eg: Choleski Key resuls: Evidence of swich from PCP o LCP changes he ransmission of foreign moneary policy shocks subsanially In he period before 99, he U.K. response resembles he classic beggarhy-neighour scenario The mued response of asse prices o he MP* shock in he recen period sugges he recen increase asse prices are aribued o oher shocks Inernaional ransmission of shocks, 7 July 9 Slide 4/4