Common Component Structural VARs

46 Pages Posted: 23 Dec 2020

See all articles by Mario Forni

Mario Forni

Università degli studi di Modena e Reggio Emilia (UNIMORE) - Faculty of Business and Economics; Centre for Economic Policy Research (CEPR)

Luca Gambetti

University of Turin

Marco Marco

Einaudi Institute for Economics and Finance (EIEF)

Luca Sala

University of Bocconi - Innocenzo Gasparini Institute for Economic Research (IGIER)

Date Written: December 1, 2020

Abstract

Small scale VAR models are subject to two major issues: first, the information set might be too narrow; second, many macroeconomic variables are measured with error. The two features produce distorted estimates of the impulse response functions. We propose a new procedure, called Common Components Structural VARs (CC-SVAR), which solves both problems. It consists in (a) treating the variables, prior to estimation, in order to extract their common components; this eliminates measurement errors; (b) estimating a VAR with m > q common components, that is a singular VAR, where q is the number of shocks driving the economy; this solves the fundamentalness problem. SVARs and CC-SVARs are compared in the empirical analysis of monetary policy and technology shocks. The results obtained by SVARs are not robust, in that they strongly depend on the choice and the treatment of the variables considered. On the contrary, using CCSVARs (i) contractionary monetary shocks produce a decrease of prices independently of the variables included in the model, (ii) irrespective of whether hours worked enter the model in log-levels or growth rates, technology improvements produce an increase in hours worked.

JEL Classification: C32, E32

Suggested Citation

Forni, Mario and Gambetti, Luca and Marco, Marco and Sala, Luca, Common Component Structural VARs (December 1, 2020). CEPR Discussion Paper No. DP15529, Available at SSRN: https://ssrn.com/abstract=3753929

Mario Forni (Contact Author)

Università degli studi di Modena e Reggio Emilia (UNIMORE) - Faculty of Business and Economics ( email )

Viale Berengario 51
41100 Modena, Modena 41100
Italy
+39 059 205 6852 (Phone)
+39 059 205 6947 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Luca Gambetti

University of Turin ( email )

Via Po 53
Torino, Turin - Piedmont 10100
Italy

Marco Marco

Einaudi Institute for Economics and Finance (EIEF) ( email )

Via Due Macelli, 73
Rome, 00187
Italy

Luca Sala

University of Bocconi - Innocenzo Gasparini Institute for Economic Research (IGIER) ( email )

Via Roentgen 1
Milan, 20136
Italy
+39 02 5836 3326 (Phone)

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