Current Account Dynamics: A SVAR Analysis When the Structural Shocks are not Orthogonal

Csar R. Sobrino- Universidad del Turabo Email: sobrinoc1@suagm.edu Ellis Heath- Valdosta State University Email: ebheath@valdosta.edu November, 2012
Abstract Using a Structural VAR specification, Kano (2008) finds two puzzles regarding the intertemporal current account approach (ICA). First it all, he finds an excessive response of the current account to the transitory shock. Also, he finds that the transitory shock to net output growth dominates current account fluctuations in the short and long run. This paper investigates the second puzzle allowing that permanent shock to net out output growth is correlated to the permanent shock to current account. For this purpose, we employ the Enders and Hurn (2008) decomposition where the structural shocks are not orthogonal as it is allowed to be in Blanchard and Quah (1989). The outcomes indicate that there is still a puzzle when the country specific permanent shock is previous to the country-specific temporary shock. However, when the country specific temporary shock is previous to the country-specific permanent shock Kanos puzzle is corrected. JEL Classification: E3, C32, F19 Keywords: structural VAR, Blanchard-Quah Decomposition, Current Account Dynamics 1

I.

Introduction

Using a Structural VAR specification, Kano (2008) finds two puzzles regarding the intertemporal current account approach (ICA). First it all, he finds an excessive response of the current account to the transitory shock, supposing a negative response of the consumption to a positive income shock. Also, he finds that the transitory shock to net output growth dominates current account fluctuations in the short and long run. However, the transitory shock does not play any role in the fluctuations of the net output growth which does not match with ICA predictions. For small open economies, according to the literature about identifying SVARs [Kano(2008), Otto(2003), Cashin and McDermott(2003), Ahmed and Park(1994)], the country-specific shocks do not affect the global process in the long run. In addition, the permanent shock to current account is allowed to be transitory to net output growth. Those studies quote Blanchard and Quah (1989), hereafter B-Q, who decompose the net output growth fluctuations into permanent and temporary shocks. Finally, a key point of this specification is the no correlation at leads of the structural innovations. On the other hand, Enders and Hurn (2008), hereafter E-H, assume correlation of the structural shocks and set a different decomposition tor the variance-covariance matrix of the structural innovations1. Focusing in second Kanos puzzle, if the country-specific disturbances are correlated at leads, either the permanent shock to net output growth can be playing a bigger role in current account fluctuations through the country specific transitory shock or the permanent shock to current account can be play a bigger role in net output growth fluctuations through the permanent shock to net output growth.
1

They use the US growth rate as the global process, Australian growth rate and Australian inflation as the domestic processes.

In this paper, I analyze the Kanos (2008) approach assuming that the structural shocks are not orthogonal. In other words, the permanent shocks to current account and the permanent shocks to net output growth rate are correlated. The model applied is corroborated using Canadian data and United Kingdom data. The central banks of these countries have applied an inflation targeting regime which is, according to E-H, a reason to assume no orthogonally of the structural shocks. In addition, the Keynesian approach indicates that expansionary fiscal policies should increase output which is another reason to not assume orthogonally. We use two schemes in the SVAR with no orthogonal shocks:1) the positive permanent shock to net output growth positively influences the permanent shock to current account; and, 2) the positive permanent shock to current account positively influences the permanent shock to net output growth. The outcomes indicate that there is still a puzzle when the country specific permanent shock is previous to the country-specific temporary shock. However, when the country specific temporary shock is previous to the country-specific permanent shock Kanos result is corrected. Section II briefly discusses the SVAR literature for small open economies and ICA predictions. Section III presents the model and methodology. Section IV presents the outcomes, and Section V concludes.

II.

SVAR literature and ICA predictions

SVAR studies for small open economies involve three processes: a global process, the domestic output growth and current account. The difference among them is focused in the worldwide process. Otto (2003), and Cashin and McDermott (2003) use the terms of trade as

the global process. Enders and Hurn (2008) use the US output growth as the global process. According to ICA, Kano (2003) employs the ex-ante global real interest rate. The identification of this system is based on the small open economy assumption and Blanchard and Quah (1989). In the first case, the permanent shocks to current account and output growth are not allowed to affect the global process over the long run. In the second case, output variations are driven by permanent and temporary shocks. So, in this scheme, the permanent shock to current account is the country-specific temporary shock or demand-side shock allowed temporary to the output growth. The permanent shock to output growth is the country-specific permanent shock or the supply-side shock. Finally, a crucial assumption is that those structural innovations are no correlated at leads. On the other hand, according to ICA, an unexpected positive output shock positively affects the current account when the innovation is temporary. In this case, households smooth their consumption through the asset accumulation. A permanent output innovation worsens the current account because consumption and investment positively responds to output shock2. In addition, global shocks are considered symmetric because it is assumed that there are only small countries. At most, Kanos empirical findings are consistent with ICA. However, he finds two puzzles. The excessive response of the current account to the country-specific temporary shock does not support ICA. This implies that the consumption falls due to a positive income shock. The second indicates that the country-specific transitory shock dominates current account fluctuations in the short and long run.

Several studies like Glick and Rogoff (1995), Iscan (2000), Hoffman (2001), Nason and Rogers (2002), and Cuado and Perez de Gracia (2005) find that productivity shocks worsen the current account.

III.

Methodology Structural VAR (SVAR)

The ex-ante global real interest rate, net output growth and current account-net output ratio are represented in the following structural VAR model !! = !"#$! =
!" !" ! ! ! !! ! ! !!

!!!! !!!! + !! !"!! !!!! +

! ! !!

!!!! !"#$!!! +

! ! !!

!"!!

!" !" ! !!

!" + !!

! ! !!

!"!! !!!! +

! ! !!

!"!! !"#$!!! +

! ! !!

!!!!

!" !" ! !!

!" + !!

In this system, the ex-ante global real interest rate evolves independently of other variables, in other words, the first equation does not included current or lagged values of the other
!" variables. This is in accordance to the open small country assumption. Likewise, !! , !! , !" !! are the global, country- specific permanent and country- specific temporary shocks. !

According to Blanchard and Quah (1989), the assumptions of orthogonal structural shocks
! ! are ! !! !! = ! , ! !! = 0, ! !! !! = 0 for all st. The long-run restrictions set that

country-specific shocks do not have effect on the global process and the country specific temporary shocks do not affect the net output growth. Enders and-Hurns Decomposition In this framework, the variance-covariance matrix of the structural disturbances is unknown, in other words, it is not the identity matrix. Transforming system (1) into the following reduced VAR
!

!! = !(0)
! !!

!!!! !!"! !!"!

0 !!!! !!"!

0 !!"! !!!!

!! !" !!!! + !(0) !! !" !!

Where the observed residuals are:

!!! 1 !!! = !!"# + !!"# !!"# !! ! !!"#

0 0 1 !!"# 0 1

!! !" !! !" !!

or !! = !(0)!!

(2)

! When the structural innovations are assumed not orthogonal, ! !! !! = !, ! ! ! !! !! = 0 for all st. Then, ! !! !! = !(0)!!(0)! .3

! !! = 0,

! ! ! In this setup, there are 9 unknowns, three elements of B(0), three variances !! , !!" and !!"

and three covariances !!,!" !!,!" and !!",!" in the variance-covariance matrix !. In addition, the country specific temporary shock does not affect the net output growth in the long run. That restriction is !!"# = ! !" (!) (3) With the variance-covariance matrix of the observed residuals and (3), there are seven equations. To get a just identified system, according to ICA, !!,!" = 0 , and !!,!" = 0, in others words, the idiosyncratic shocks are correlated at leads.

Scheme I According to Enders and Hurn (2007), in a standard AD-AS model, the country-specific temporary shock should positively respond to positive country-specific permanent shock due to monetary intervention. In inflation targeting regimes, after an expansion of the supply curve, the price level is restored due to a monetary expansion. This assumption points out the second puzzle found by Kano (2007) where the country specific shock are too persistent in current account fluctuations, then, the reason of that persistence could be that country specific temporary shock is affected by the country specific permanent shock. Therefore, this scheme shows that dependency. In addition, the country specific temporary shock responds
3

! In the standard BQ method, ! !! !! = ! (0)! (0)!

to a pure random demand-side shock (!), too. The country-specific temporary innovation is the following form:
!" !" !! = !! !! + !! ! !" !" The assumptions are: !! ~ N(0,!! ), ! !! !! = 0, ! !! !! !

= 0, ! !! !! = 0 Then, the

! ! ! ! ! variance and covariances are: !!" = ! !! !!" + !! and, !!"!" = !! !!" . In this framework,

c1 is expected to be positive because, in inflation targeting regimes, monetary transitory

shocks positively respond to positive supply shocks. The variance-covariance matrix of observed residuals is:
! ! !! !! = !(0)!!(0)!

! !! !!

1 = !!"#

0 0 1 !!"# 0 1

! !! 0 0

0 ! !!" ! !! !!"

0 ! !! !!" ! ! ! !! !!" + !!

1 0 1 0 !!"#

!!"# 0 1

Where: = !!"# + !!"# !!"# !

! !! !!

!! = !! !!"# !!

0 !!" !! !!"

!! !!"# !! ! 0 !! 0

!! !!" !!"# !!

!!"# !! !! !!" !!

Where: =1+!! !!"#

! !! ! !! ! !!"# !! ! !! ! ! ! ! ! !! + ! !!" + !!"# !! ! ! ! !!"# !! + !! !!" + !!"# !! ! !!"# !! ! ! ! !!"# !! + !! !!" + !!"# !! ! ! ! ! ! !!"# !! + !! !!" + !!

! ! !! !! =

Scheme II This is a Keynesian scheme where demand fluctuations should affect output, and then the country-specific permanent shock should positively respond to positive country-specific temporary permanent shock. This assumption points out also the second puzzle found by

Kano (2007), but this scheme looks for correcting the effects of the country specific temporary shock on the net output growth. Therefore, this scheme shows that dependency of country specific permanent shock to country specific temporary shock. In addition, the country specific permanent shock responds to a pure random supply-side shock (!), too. The country-specific permanent innovation is the following form:
!" !" !! = !! !! + !! !" !" ! The assumptions are: !! ~ N(0,!! ), ! !! !! = 0, ! !! !! !

= 0, ! !! !! = 0 Then, the

! ! ! ! ! variance and covariances are: !!" = ! !! !!" + !! and, !!"!" = !! !!" . In this framework,

c2 is expected to be positive because, country specific permanent shocks positively respond to

positive fiscal shocks. The variance-covariance matrix of observed residuals is:
! ! !! !! = !(0)!!(0)!

! !! !!

1 = !!"#

0 0 1 !!"# 0 1

! !! 0 0

0 ! ! ! !! !!" + !! ! !! !!"

0 ! !! !!" ! !!!"

1 0 1 0 !!"#

!!"# 0 1

Where: = !!"# + !!"# !!"# !

! !! !!

!! = !! !!"# !!

0 !! 0

0 !! !!" ! 0 !!" 0

!! !! !!"

!!"# !! 0 !!"

Where: = !! + !!"#
! !! ! ! !! !! = ! !! ! !!"# !! ! !! ! ! ! ! !! + !! + ! !!" ! ! !!"# !! + !! ! !!"# !! ! ! !!"# !! + !! ! ! ! !!"# !! + !!"

Data For the period 1971:1- 2006:2, quarterly data is obtained from the International Financial Statistics at the IMF. All processes are seasonally adjusted. Following the Barro and Sala-iMartin (1990) method, the global ex ante real interest rate is computed. For the G7

countries, it is collected three-month T bills and money market interest rates. The expected inflation rate for each G7 country is forecasted using a six-quarter autoregression. The exante real interest rate is difference between the nominal interest rate and the forecasted inflation. Then, the ex-ante global interest rate is a weighted average of the ex-ante real interest rate. The net output is the GDP minus investment minus government expenses minus stock variation. The current account is the real GNP minus consumption minus investment minus government expenses minus stock variation. Table 1 shows the ADF test. All processes are stationary. Finally, the AIC test indicates the reduced VAR for Canada has one lag, and for UK two lags.

IV-Outcomes Table 2 shows the variances of the structural shocks and the coefficient of correlation is positive for UK and Canada in both schemes. It was expected to be positive and it is positive. Scheme I Forecast-error variance decomposition Table 3 shows the sources of net output and current account fluctuations in Canada and United Kingdom. For Canada, the global shock plays no role on the variations of the current account. In addition, the country specific transitory shock that still plays the biggest role in the current account fluctuations; almost explain 70 percent of the variations in current

account. In addition, the country specific permanent shock increases its importance in current variations with respect to Kanos outcomes. It explains around 30 percent. Finally, the permanent shock to net output growth explains most of the net output growth fluctuations. For United Kingdom, the global shock plays no role on the variations of the current account in Canada. In addition, the country specific transitory shocks that, still play the biggest role in the current account fluctuations; almost explain 77 percent of the variations in current account. Moreover, the country specific permanent shock increases its importance in current variations with respect to Kanos outcomes. It explains around 22 percent. Finally, the permanent shock to net output growth explains most of the net output growth fluctuations. In this scheme, the second puzzle remains the same which is that country specific transitory shock play the biggest role in current account variations. Impulse response function Figures 6 and 7 show the responses of the current account to global, country specific permanent and the country specific temporary shocks in both countries. Over 20 quarters, for Canada and UK, the global shock does not affect the current account. The current account positively responds to both country specific shocks. Over 20 quarters, for Canada and UK, the global shock does not affect the net output growth. The country specific permanent shock has an initial impact on the net output growth, and after, there is a flat response. The net output growth does not respond to the country transitory shock. The result support basic predictions of the ICA but the puzzles that are mentioned by Kano remains there.

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Scheme II Forecast-error variance decomposition Table 4 shows the sources of net output and current account fluctuations in Canada and United Kingdom. For Canada, the global shock plays no role on the variations of the current account. In addition, the country-specific transitory shocks still play the biggest role in the current account fluctuations; almost explain 100 percent of the variations in current account. In addition, the country specific permanent shocks do not play any role in current account variations which is similar to Kanos outcomes. However, the country specific temporary shock increases its importance in net output growth variations, explaining by 30 percent of its movements. The permanent shock to net output growth almost explains 70 percent of the output growth fluctuations. For United Kingdom, the global shock plays no role on the variations of the current account in Canada. In addition, the country-specific transitory shocks still play the biggest role in the current account fluctuations; almost explain 100 percent of the variations in current account. In addition, the country specific permanent shocks do not play any role in current account variations, which is similar to Kanos outcomes. However, the country specific temporary shock also increases its importance in net output growth variations, explaining by 20% of its movements. The permanent shock to net output growth almost explains 80% of the output growth fluctuations. In this scheme, the second puzzle is corrected because the country specific temporary shocks play the biggest role in current account fluctuations and influence the variations of the net output growth.

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Impulse response function Figures 8 and 9 show the responses of the current account to global, country specific permanent and the country specific temporary shocks in both countries. Over 20 quarters, for Canada and UK, the global shock does not affect the current account. The current account positively responds to the country-specific transitory shock. Over 20 quarters, for Canada and UK, the global shock does not affect the net output growth. Both country specific shocks have an initial impact on the net output growth, and after, there is a flat response. The result supports basic predictions of the ICA.

V-Conclusions This paper investigates the second puzzle found by Kano (2007) regarding ICA. This puzzle indicates that transitory shock to net output growth dominates current account fluctuations in the short and long run, but this shock does not play any role in the fluctuations of the net output growth which does not match with ICA predictions. Kano (2007) uses a SVAR and, to identify the temporary and permanent shocks, he uses Blanchard and Quah (1989) decomposition. In this setting, structural shocks are not orthogonal. Then, it is not allowed correlation among structural shocks at leads. In addition, in our setting, we employ Enders and Hurn (2007) decomposition where the structural shocks are not orthogonal. According to this, we set two schemes 1) the country specific permanent shock is previous to the country-specific temporary shock, and 2) the country specific temporary shock is previous to the country-specific permanent shock. The both schemes look for to correct Kanos second puzzle.

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The model applied is corroborated using Canadian data and United Kingdom data. The central banks of these countries have applied an inflation targeting regime which is a reason to assume no orthogonally of the structural shocks. In addition, the Keynesian approach indicates that expansionary fiscal policies should increase output which is another reason to not assume orthogonally. The outcomes indicate that both puzzles are still there under Scheme I. However, when the country specific temporary shock is previous to the countryspecific permanent shock Kanos second puzzle disappears.

References Ahmed S., and J. H. Park (1994) Sources of Macroeconomic Fluctuations in Small Open Economies Journal of Macroeconomics 16, 1-36. Blanchard, O.J., and D. Quah (1989) The Dynamic Effects of Aggregate Demand and Supply Disturbances American Economic Review 79, 655-673. Cuado J., and F. Perez de Gracia (2005) Current Account and Productivity: Evidence for some European Countries Journal(of(Policy(Modeling 27, 75-89.! Cashin, P., and C.J. McDermott (2002) Terms of Trade Shocks and the Current Account: Evidence from Five Industrial Countries Open Economies Review 13, 219-235. Enders,W., and S. Hurn (2007) Identifying Aggregate Demand and Supply Shocks in a Small Open Economy Oxford Economic Papers 59, 411-429. Glick, R., and K. Rogoff (1995) Global versus Country-Specific Productivity Shocks and the Current Account Journal(of(Monetary(Economics 35, 159-192. IMF International Financial Statistics

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Iscan! T.! (2000)! The! Terms! of! Trade,! Productivity! Growth! and! the! Current! Account! Journal(of(Monetary(Economics!45,!587D611.! Kano T. (2008) A Structural VAR Approach to the Intertemporal Model of the Current Account , Journal of International Money and Finance. 27, 757-759! Nason,! J.M.,! and! J.H.! Rogers! (2002)! Investment! and! the! Current! Account! in! the! Short! Run!and!the!Long!Run!Journal(of(Money,(Credit(and(Banking!34,!967D986. Otto, G. (2003) Terms of Trade Shocks and The Balance of Trade: There is a HarbergerLaursen-Metzler Effect Journal of International Money and Finance 22, 155-184.

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Figure 1: Ex- ante Global Real Interest Rate

5.0

Ex-ante Global Real Interest Rate

2.5

0.0

-2.5

-5.0 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006

Figure 2: Canada-Current Account/Net Output

0.08 0.06 0.04 0.02 0.00 -0.02 -0.04 -0.06 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006

Canada: Current Account-Net Output

Figure 3: Canada-Net Output Growth

0.04 0.03 0.02 0.01 0.00 -0.01 -0.02 -0.03 -0.04 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006

Canada: Net Output Growth

Figure 4: United Kingdom-Current Account/Net Output

0.050 0.025 -0.000 -0.025 -0.050 -0.075 -0.100 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006

United Kingdom: Current Account-Net Output

Figure 5: United Kingdom-Net Output Growth

0.075

United Kingdom: Net Output Growth

0.050

0.025

0.000

-0.025

-0.050 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006

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Figure 6:Scheme I-Standardized Impulse Response Functions for Canada

Output growth responses
Panel a: Response to Global real interest rate
1.0 0.8 0.6 0.4 0.2 0.0 -0.2 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 1.0 0.8 0.6 0.4 0.2 0.0 -0.2 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19

Current account responses

Panel d: Response to Global real interest rate

Panel b: Response to country-specific permanent shock

1.00 0.75 0.50 0.25 0.00 -0.25 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 1.0 0.8 0.6 0.4 0.2 0.0 0 1 2

Panel e: Response to country-specific permanent shock

10

11

12

13

14

15

16

17

18

19

Panel c: Response to country-specific temporary shock

1.0 0.8 0.6 0.4 0.2 0.0 -0.2 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 1 2

Panel f: Response to country-specific temporary shock

10

11

12

13

14

15

16

17

18

19

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Figure 7:Scheme I-Standardized Impulse Response Functions for UK

Output growth responses
Panel a: Response to Global real interest rate
1.0 0.8 0.6 0.4 0.2 0.0 -0.2 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 1.0 0.8 0.6 0.4 0.2 0.0 -0.2 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19

Current account responses

Panel d: Response to Global real interest rate

Panel b: Response to country-specific permanent shock

1.0 0.8 0.6 0.4 0.2 0.0 -0.2 -0.4 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 0.2 0.0 0 1 2 0.6 0.4 1.0 0.8

Panel e: Response to country-specific permanent shock

10

11

12

13

14

15

16

17

18

19

Panel c: Response to country-specific temporary shock

1.0 0.8 0.6 0.4 0.2 0.0 -0.2 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 1 2

Panel f: Response to country-specific temporary shock

10

11

12

13

14

15

16

17

18

19

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Figure 8:Scheme II-Standardized Impulse Response Functions for Canada

Output growth responses
Panel a: Response to Global real interest rate
1.0 0.8 0.6 0.4 0.2 0.0 -0.2 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 1.0 0.8 0.6 0.4 0.2 0.0 -0.2 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19

Current account responses

Panel d: Response to Global real interest rate

Panel b: Response to country-specific permanent shock

1.0 0.8 0.6 0.4 0.2 0.0 -0.2 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 1.0 0.8 0.6 0.4 0.2 0.0 -0.2 0 1 2

Panel e: Response to country-specific permanent shock

10

11

12

13

14

15

16

17

18

19

Panel c: Response to country-specific temporary shock

1.00 0.75 0.50 0.25 0.00 -0.25 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 1 2

Panel f: Response to country-specific temporary shock

10

11

12

13

14

15

16

17

18

19

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Figure 9:Scheme II-Standardized Impulse Response Functions for UK

Output growth responses
Panel a: Response to Global real interest rate
1.0 0.8 0.6 0.4 0.2 0.0 -0.2 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 1.0 0.8 0.6 0.4 0.2 0.0 -0.2 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19

Current account responses

Panel d: Response to Global real interest rate

Panel b: Response to country-specific permanent shock

1.0 0.8 0.6 0.4 0.2 0.0 -0.2 -0.4 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 1.0 0.8 0.6 0.4 0.2 0.0 -0.2 0 1 2

Panel e: Response to country-specific permanent shock

10

11

12

13

14

15

16

17

18

19

Panel c: Response to country-specific temporary shock

1.00 0.75 0.50 0.25 0.00 -0.25 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 1 2

Panel f: Response to country-specific temporary shock

10

11

12

13

14

15

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Canada UK

TABLE 1: ADF TEST 1 Lag 3 Lags 5 Lags Global Real Interest Rate -2.45349** -2.30030** -2.10473** Current Account -2.71613*** -2.82789*** -2.47400** Net output Growth -6.27231*** -3.41147*** -2.45457** Current Account -2.23561** -2.05012** -2.22889** Net output Growth -7.90389*** -3.83922*** -3.36284*** 1% 5% 10% -2.5802 -1.9421 -1.6169

Critical Values

TABLE 2: VARIANCES OF STRUCTURAL SHOCKS AND THE CORRELATION COEFFICIENTS OF THE IDIOSYNCRATIC SHOCKS! ! ! ! !!" 1 2 ! !! !!" Canada Scheme I 0.42654 1.61E-04 1.82E-04 0.69 Scheme II 0.42654 1.61E-04 1.82E-04 0.61 UK Scheme I 0.41027 1.95E-04 2.26E-04 0.53 Scheme II 0.41027 1.95E-04 2.26E-04 0.46 !!" !!" Notes: !! = !! !!" , !! = !! !!"

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TABLE 3: SCHEME I- FORECAST -ERROR VARIANCE DECOMPOSITION (%) Canada UK ! ! !" !" !" !" Quarters !! !! !! !! !! !! Net output growth rate 1 0.00 99.47 0.53 0.00 99.95 0.05 2 0.00 98.79 1.21 0.00 99.25 0.75 3 0.00 98.57 1.43 0.00 99.15 0.85 4 0.00 98.36 1.64 0.00 99.11 0.89 5 0.00 98.19 1.80 0.00 99.11 0.89 10 0.00 97.76 2.24 0.00 99.10 0.90 20 0.00 97.58 2.42 0.00 99.09 0.91 Current account/Net output 1 0.00 32.03 67.97 0.00 21.79 78.21 2 0.00 30.79 69.21 0.00 22.98 77.02 3 0.00 30.53 69.47 0.00 22.11 77.89 4 0.00 30.38 69.62 0.00 22.18 77.82 5 0.00 30.30 69.71 0.00 22.09 77.91 10 0.00 30.14 69.86 0.00 21.96 78.03 20 0.00 30.10 69.90 0.01 21.92 78.08 TABLE 4: SCHEME II- FORECAST -ERROR VARIANCE DECOMPOSITION (%) Canada UK ! ! !" !" !" !" Quarters !! !! !! !! !! !! Net output growth rate 1 0.00 68.20 31.80 0.00 81.34 18.66 2 0.00 67.05 32.95 0.00 79.57 20.43 3 0.00 67.06 32.94 0.00 79.48 20.52 4 0.00 66.93 33.07 0.00 79.48 20.53 5 0.00 66.85 33.15 0.00 79.47 20.53 10 0.00 66.63 33.37 0.00 79.46 20.54 20 0.00 66.54 33.46 0.00 79.46 20.54 Current account/Net output 1 0.00 0.00 100.00 0.00 0.00 100.00 2 0.00 0.09 99.91 0.00 0.11 99.88 3 0.00 0.10 99.90 0.00 0.13 99.87 4 0.00 0.11 99.89 0.00 0.11 99.88 5 0.00 0.11 99.89 0.00 0.10 99.90 10 0.00 0.12 99.88 0.01 0.08 99.92 20 0.00 0.12 99.88 0.01 0.07 99.92

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