Identifying Global and National Output and Fiscal Policy Shocks Using a GVAR

Chudik, Alexander; Mohaddes, Kamiar; Pesaran, M. Hashem

doi:10.24149/gwp351

Working Paper

Identifying Global and National Output and Fiscal Policy Shocks Using a GVAR

Abstract: The paper contributes to the growing Global VAR (GVAR) literature by showing how global and national shocks can be identified within a GVAR framework. The usefulness of the proposed approach is illustrated in an application to the analysis of the interactions between public debt and real output growth in a multi-country setting, and the results are compared to those obtained from standard single-country VAR analysis. We find that on average (across countries) global shocks explain about one-third of the long-horizon forecast error variance of output growth, and about one-fifth of the long-run variance of the rate of change of debt-to-GDP. Evidence on the degree of cross-sectional dependence in these variables and their innovations is exploited to identify the global shocks, and priors are used to identify the national shocks within a Bayesian framework. It is found that posterior median debt elasticity with respect to output is much larger when the rise in output is due to a fiscal policy shock, as compared to when the rise in output is due to a positive technology shock. The cross-country average of the median debt elasticity is 1.58 when the rise in output is due to a fiscal expansion as compared to 0.75 when the rise in output follows from a favorable output shock.

Keywords: factor-augmented VARs; Global VARs; identification of global and country specific shocks; Bayesian analysis; public debt; output growth; debt elasticity;

JEL Classification: C30; E62; H6;

https://doi.org/10.24149/gwp351