International Transmission of Shocks: A Time-Varying Factor-Augmented VAR Approach to the Open Economy

44 Pages Posted: 30 May 2011

See all articles by Philip Liu

Philip Liu

International Monetary Fund (IMF)

Haroon Mumtaz

University of London - School of Sciences

Angeliki Theophilopoulou

Westminster Business School

Date Written: May 27, 2011

Abstract

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.

Keywords: factor augmented VAR, time-variation, Gibbs sampling.

Suggested Citation

Liu, Philip and Mumtaz, Haroon and Theophilopoulou, Angeliki, International Transmission of Shocks: A Time-Varying Factor-Augmented VAR Approach to the Open Economy (May 27, 2011). Bank of England Working Paper No. 425. Available at SSRN: https://ssrn.com/abstract=1854325 or http://dx.doi.org/10.2139/ssrn.1854325

Philip Liu

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Haroon Mumtaz (Contact Author)

University of London - School of Sciences ( email )

London, WC1E 7HX
United Kingdom

Angeliki Theophilopoulou

Westminster Business School ( email )

309 Regent Street
London, W1R 8AL
United Kingdom

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