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International transmission of shocks: a time-varying factor-augmented VAR approach to the open economy

Author

Listed:
  • Liu, Philip

    () (International Monetary Fund)

  • Mumtaz, Haroon

    () (Bank of England)

  • Theophilopoulou, Angeliki

    () (University of Westminister)

Abstract

A growing literature has documented changes to the dynamics of key macroeconomic variables in industrialised 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.

Suggested Citation

  • Liu, Philip & Mumtaz, Haroon & Theophilopoulou, Angeliki, 2011. "International transmission of shocks: a time-varying factor-augmented VAR approach to the open economy," Bank of England working papers 425, Bank of England.
  • Handle: RePEc:boe:boeewp:0425
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    References listed on IDEAS

    as
    1. Bianchi, Francesco & Mumtaz, Haroon & Surico, Paolo, 2009. "Dynamics of the term structure of UK interest rates," Bank of England working papers 363, Bank of England.
    2. Haroon Mumtaz & Özlem Oomen & Jian Wang, 2006. "Exchange rate pass-through into UK import prices," Bank of England working papers 312, Bank of England.
    3. Cushman, David O. & Zha, Tao, 1997. "Identifying monetary policy in a small open economy under flexible exchange rates," Journal of Monetary Economics, Elsevier, vol. 39(3), pages 433-448, August.
    4. Thomas Lubik & Frank Schorfheide, 2005. "A Bayesian Look at New Open Economy Macroeconomics," Economics Working Paper Archive 521, The Johns Hopkins University,Department of Economics.
    5. Juan Francisco Rubio-Ramírez & Daniel F. Waggoner & Tao Zha, 2005. "Markov-switching structural vector autoregressions: theory and application," FRB Atlanta Working Paper 2005-27, Federal Reserve Bank of Atlanta.
    6. Marco Del Negro & Christopher Otrok, 2008. "Dynamic factor models with time-varying parameters: measuring changes in international business cycles," Staff Reports 326, Federal Reserve Bank of New York.
    7. Koop, Gary & Pesaran, M. Hashem & Potter, Simon M., 1996. "Impulse response analysis in nonlinear multivariate models," Journal of Econometrics, Elsevier, vol. 74(1), pages 119-147, September.
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    Citations

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    Cited by:

    1. Duchi, Fabio & Elbourne, Adam, 2016. "Credit supply shocks in the Netherlands," Journal of Macroeconomics, Elsevier, vol. 50(C), pages 51-71.
    2. Eickmeier, Sandra & Lemke, Wolfgang & Marcellino, Massimiliano, 2011. "Classical time-varying FAVAR models - Estimation, forecasting and structural analysis," CEPR Discussion Papers 8321, C.E.P.R. Discussion Papers.
    3. repec:eee:inecon:v:107:y:2017:i:c:p:1-18 is not listed on IDEAS
    4. Angela Abbate & Sandra Eickmeier & Wolfgang Lemke & Massimiliano Marcellino, 2016. "The Changing International Transmission of Financial Shocks: Evidence from a Classical Time‐Varying FAVAR," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 48(4), pages 573-601, June.
    5. Sandra Eickmeier & Wolfgang Lemke & Massimiliano Marcellino, 2015. "Classical time varying factor-augmented vector auto-regressive models—estimation, forecasting and structural analysis," Journal of the Royal Statistical Society Series A, Royal Statistical Society, vol. 178(3), pages 493-533, June.
    6. Knut Are Aastveit & Hilde C. Bjørnland & Leif Anders Thorsrud, 2016. "The World Is Not Enough! Small Open Economies and Regional Dependence," Scandinavian Journal of Economics, Wiley Blackwell, vol. 118(1), pages 168-195, January.
    7. Forbes, Kristin & Hjortsoe, Ida & Nenova, Tsvetelina, 2015. "The shocks matter: improving our estimates of exchange rate pass-through," Discussion Papers 43, Monetary Policy Committee Unit, Bank of England.
    8. Eickmeier, Sandra, 2009. "Analyse der Übertragung US-amerikanischer Schocks auf Deutschland auf Basis eines FAVAR," Working Papers 04/2009, German Council of Economic Experts / Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung.
    9. Muhammad Khan, 2013. "Inflation and Sectoral Output Growth Variability in Bulgaria," Comparative Economic Studies, Palgrave Macmillan;Association for Comparative Economic Studies, vol. 55(4), pages 687-704, December.
    10. Philip Liu & Haroon Mumtaz, 2011. "Evolving Macroeconomic Dynamics in a Small Open Economy: An Estimated Markov Switching DSGE Model for the UK," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43(7), pages 1443-1474, October.
    11. Yoshiyuki Fukuda & Yuki Kimura & Nao Sudo & Hiroshi Ugai, 2013. "Cross-country Transmission Effect of the U.S. Monetary Shock under Global Integration," Bank of Japan Working Paper Series 13-E-16, Bank of Japan.
    12. Molteni, Francesco & Pappa, Evi, 2017. "The Combination of Monetary and Fiscal Policy Shocks: A TVP-FAVAR Approach," CEPR Discussion Papers 12541, C.E.P.R. Discussion Papers.
    13. Eickmeier Sandra, 2010. "Analyse der Übertragung US-amerikanischer Schocks auf Deutschland auf Basis eines FAVAR / A FAVAR-based Analysis of the Transmission of US Shocks to Germany," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), De Gruyter, vol. 230(5), pages 571-600, October.
    14. Forbes, Kristin & Hjortsoe, Ida & Nenova, Tsvetelina, 2017. "Shocks versus structure: explaining differences in exchange rate pass-through across countries and time," Discussion Papers 50, Monetary Policy Committee Unit, Bank of England.
    15. Hacioglu, Sinem & Tuzcuoglu, Kerem, 2016. "Interpreting the latent dynamic factors by threshold FAVAR model," Bank of England working papers 622, Bank of England.
    16. Goodness C. Aye & Mehmet Balcilar & Rangan Gupta, 2016. "The Effectiveness of Monetary Policy in South Africa under Inflation Targeting: Evidence from a Time-Varying Factor-Augmented Vector Autoregressive Model," Working Papers 201653, University of Pretoria, Department of Economics.
    17. Jakob Guldbæk Mikkelsen & Eric Hillebrand & Giovanni Urga, 2015. "Maximum Likelihood Estimation of Time-Varying Loadings in High-Dimensional Factor Models," CREATES Research Papers 2015-61, Department of Economics and Business Economics, Aarhus University.
    18. Andrew Binning, 2013. "Underidentified SVAR models: A framework for combining short and long-run restrictions with sign-restrictions," Working Paper 2013/14, Norges Bank.

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    Keywords

    Factor augmented VAR; Time-variation; Gibbs sampling.;

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