Covid and War shocks

We estimate a small open-economy DSGE model for the euro area using data that span the COVID-19 pandemic, the inflation surge of 2022, and the onset of the Russo–Ukrainian war. The model incorporates COVID-specific shocks—distinct from standard ones in volatility and persistence—whose inclusion is warranted when conventional shocks fail to match the data without an abnormal increase in volatility. Accounting for these shocks is crucial: their omission significantly alters model dynamics, particularly impulse response functions, and distorts the interpretation of economic mechanisms. The pandemic recession is primarily driven by “forced-savings” shocks from domestic and external households and by production constraints, while labor hoarding emerges endogenously as a firm-level response to weak demand. Applying the same approach to identify war-specific shocks yields negligible effects. The 2022 inflation surge is fully explained by standard price-markup shocks, amplified by a sequence of external inflationary pressures, that can be replicated from standard shocks. The proposed specification outperforms alternative formulations, demonstrating that omitting any pandemic-related component or the rebound effect is sufficient to alter parameter estimates, impulse responses, and historical decompositions, as well as to lower the marginal data density.