Trabajo Práctico 5

Vectores Autorregresivos
Estructurales
Jorge Restrepo

Instituto de Capacitación del FMI

Diciembre 2013
Curso de Pronostico Macroeconómico
BTC13.12 1
 Contents
VAR Identification
1. Recursive-Choleski
1.1 Sims EER(92)

2. Semi or non recursive

2.1 Blanchard-Perotti (fiscal multipliers)

3. Short and long-run restrictions

3.1 Galí (QJE,1992)

4. Long-run restrictions
4.1 Blanchard-Quah

2
 VARs
• VARs are estimated to provide empirical evidence on the
response of macro variables to policy shocks.
• VARs provide stylized facts to be included in theoretical
models.
• VARs help decide between competing theoretical models.

• VARs concentrate on identification of shocks and the

response of the system to them by analyzing impulse
responses, as well as variance and historic decompositions.

• The purpose is to uncover the structural model using a

minimum set of assumptions about the structural
relationships among variables.
3
 1.1 Sims (1992)
―Interpreting the macroeconomic time series facts‖

• Ordering, price puzzle, discussion of economic models as an

Illustration of VAR agenda.

• He included monthly data for the following variables: Federal

funds rate (ff) and the logs of M1 (lm), CPI (lp), Industrial
production (ly). In this order. VAR has 14 lags (58:04-91:2).

• The policy variable was ordered first. So, the ordering says
that authorities only observe non policy variables with a lag.

• The policy variable affects contemporaneously all other

variables. The most endogenous variable is ordered last.

• Puzzle: prices go up after a funds rate hike.

4
 1.1 Sims (1992) Response to Cholesky One S.D. Innov ations
Response of FF to FF Response of FF to LM Response of FF to LP Response of FF to LY
.8 .8 .8 .8

.6 .6 .6 .6

.4 .4 .4 .4

.2 .2 .2 .2

.0 .0 .0 .0

-.2 -.2 -.2 -.2

5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45

Response of LM to FF Response of LM to LM Response of LM to LP Response of LM to LY

.006 .006 .006 .006

.004 .004 .004 .004

.002 .002 .002 .002

.000 .000 .000 .000

-.002 -.002 -.002 -.002

-.004 -.004 -.004 -.004

-.006 -.006 -.006 -.006

5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45

Response of LP to FF Response of LP to LM Response of LP to LP Response of LP to LY

.012 .012 .012 .012

.008 .008 .008 .008

.004 .004 .004 .004

.000 .000 .000 .000

-.004 -.004 -.004 -.004

5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45

Response of LY to FF Response of LY to LM Response of LY to LP Response of LY to LY

.015 .015 .015 .015

.010 .010 .010 .010

.005 .005 .005 .005

.000 .000 .000 .000

-.005 -.005 -.005 -.005

-.010
5 10 15 20 25 30 35 40 45
-.010
5 10 15 20 25 30 35 40 45
-.010
5 10 15 20 25 30 35 40 45
-.010
5 10 15 20 25 30 35 40 45
5
 1.1 Sims (1992)
• This pattern does not fit the monetarist/IS-LM interpretation.

• If a monetary contraction reduces aggregate demand,

lowering output, it cannot be associated with inflation.

• The VAR could be mis specified. For instance there could be

a leading indicator for inflation to which the FED reacts.

• Authorities could know that inflationary pressures are about

to arrive and counteract them by raising the interest rate.

6
 1.1 Sims (1992)
• Prices would increase but by less than without the
contraction. Output would fall and even the currency.
• Sims included commodity prices to solve the puzzle.
• The results are mixed for both monetarist/ISLM and RBC
interpretation of the data:
– 1) prices do not fall with the policy shock; 2) the fall of output and
money after an interest rate shock is not present in RBC models. RBC
models do not match these multivariate impulse-responses.

• The identification strategy used to interpret the data relies on

the assumption that innovations to i represent policy shocks.
• Illustration of the VAR agenda. Assess the empirical support
for conflicting views (models) about monetary policy.
7
 1.1 Sims (1992)
Fig 5 C. Sims, Interpreting…
Res pons e of FF to FF Res pons e of FF to LXR Res pons e of FF to LCP Res pons e of FF to LM Res pons e of FF to LP Res pons e of FF to LY
.8 .8 .8 .8 .8 .8

.4 .4 .4 .4 .4 .4

.0 .0 .0 .0 .0 .0

-.4 -.4 -.4 -.4 -.4 -.4

5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45

Res pons e of LXR to FF Res pons e of LXR to LXR Res pons e of LXR to LCP Res pons e of LXR to LM Res pons e of LXR to LP Res pons e of LXR to LY
.015 .015 .015 .015 .015 .015

.010 .010 .010 .010 .010 .010

.005 .005 .005 .005 .005 .005

.000 .000 .000 .000 .000 .000

-.005 -.005 -.005 -.005 -.005 -.005

-.010 -.010 -.010 -.010 -.010 -.010

5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45

Res pons e of LCP to FF Res pons e of LCP to LXR Res pons e of LCP to LCP Res pons e of LCP to LM Res pons e of LCP to LP Res pons e of LCP to LY
.04 .04 .04 .04 .04 .04

.02 .02 .02 .02 .02 .02

.00 .00 .00 .00 .00 .00

-.02 -.02 -.02 -.02 -.02 -.02

-.04 -.04 -.04 -.04 -.04 -.04

5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45

Res pons e of LM to FF Res pons e of LM to LXR Res pons e of LM to LCP Res pons e of LM to LM Res pons e of LM to LP Res pons e of LM to LY
.006 .006 .006 .006 .006 .006

.004 .004 .004 .004 .004 .004

.002 .002 .002 .002 .002 .002

.000 .000 .000 .000 .000 .000

-.002 -.002 -.002 -.002 -.002 -.002

-.004 -.004 -.004 -.004 -.004 -.004

5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45

Res pons e of LP to FF Res pons e of LP to LXR Res pons e of LP to LCP Res pons e of LP to LM Res pons e of LP to LP Res pons e of LP to LY
.008 .008 .008 .008 .008 .008

.004 .004 .004 .004 .004 .004

.000 .000 .000 .000 .000 .000

-.004 -.004 -.004 -.004 -.004 -.004

-.008 -.008 -.008 -.008 -.008 -.008

5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45

Res pons e of LY to FF Res pons e of LY to LXR Res pons e of LY to LCP Res pons e of LY to LM Res pons e of LY to LP Res pons e of LY to LY
.010 .010 .010 .010 .010 .010

.005 .005 .005 .005 .005 .005

.000 .000 .000 .000 .000 .000

-.005 -.005 -.005 -.005 -.005 -.005

-.010 -.010 -.010 -.010 -.010 -.010

5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45 5 10 15 20 25 30 35 40 45
8
 2.1 Blanchard and Perotti (2002)
• In order to estimate the effects of fiscal policy on the economy
one could identify fiscal ‗experiments‘, i.e., episodes of truly
exogenous fiscal expansion.
– Romer and Romer (2008) on the impact of tax policy changes in
the U.S. This is known as the narrative approach.

• The results are specific to the type of fiscal measure studied,

the prevailing economic conditions at the time of
implementation, etc.

• What exactly is a ―truly exogenous fiscal expansion‖?

9
 2.1 Blanchard and Perotti (2002)
Endogeneity bias problem
Consider the following timeline of events:
1. A negative exogenous shock to private demand is
anticipated by the authorities…

2. who increase public spending causing…

3. an increase in the deficit…
4. while total output still declines.

• Wrong conclusion: the multiplier is negative.

• The fiscal reaction was endogenous—reacting to the

expected output development.

10
 2.1 Blanchard and Perotti (2002)
• An alternative is to identify econometrically exogenous
movements in public expenditure/ taxes.

– Blanchard and Perotti (2002): two alternatives i) taxes

move first; ii) the government expenditure variable moves
first.

• VARs give the response of the economy, taking into account

also the monetary policy response  interest rates respond
to the fiscal shock.

11
 2.1 Blanchard and Perotti (2002)
• There are exogenous fiscal shocks.
• At high frequencies, there is no discretionary response of
fiscal policy to unexpected movements in y. It takes time
• Expenditure (spending): government consumption and
investment.
• Revenue: total taxes minus transfers, including interest
payments.
• The VAR specification is Yt  A( L, q)Yt 1  Ut where
• Yt  Tt , Gt , X t  are the logarithms of quarterly taxes,
'

spending, and GDP, respectively. In real per capita terms.

• And U t  tt , gt , xt  vector of reduced form residuals.
'

12
 2.1 Blanchard and Perotti (2002)
• The reduced form residuals are combinations of the
structural shocks e: tt  a1 xt  a2et  et
g t

gt  b1 xt  b2ett  etg
xt  c1tt  c2 gt  etx
• Unexpected movements in taxes, within a quarter, are due
to unexpected movements in GDP ( a1 xt ), structural shocks
g
to spending (a2 et ), and to structural shocks to taxes ( ett ).

• They constructed the elasticities to output of government

purchases and taxes minus transfers: a1 , b1 These capture:

• Automatic effect of activity on taxes and spending under the

existing fiscal rules and any discretionary adjustment made
to fiscal policy within the quarter. They rule out the latter.
13
 2.1 Blanchard and Perotti (2002)
• The average measure of a1 = 2.08.
• Now they construct the cyclically adjusted reduced form tax
and spending residuals tt  tt  a1 xt and gt  gt  b1 xt  gt
' '

• Because b1  0
' ' x
• tt , gt may be correlated with each other but not with et
• So they can be used as instruments to estimate c1 and c2
• In: tx  c t
1 t  c g
2 t  et
x

• Now they estimate a2 , b2. When taxes and spending

increase at the same time, are taxes responding to
spending? a2  0, b2  0 Or the other way around?
• to do that they identify the shocks in two ways: i) the
assume that tax decisions come first a2  0, and estimate
b2
14
 2.1 Blanchard and Perotti (2002)
• to do that they identify the shocks in two ways: i) they
assume that tax decisions come first a2  0, and estimate
b2 ; ii) they assume spending decisions come first b2  0 and
estimate a2 .

• To obtain impulse responses of a tax shock a2  0,

and remember b1  0,

 1 0 a1   utt   1 a2 0  ett 

 0   g    g
 1 b1  ut   b2 1 0 et 
 c1 c2 1   utx   0 0 1   etx 

• Now EVIEWS
15
 2.1 Blanchard and Perotti (2002)
TAX SHOCK

scalar a1 = 2.08 tt  a1 xt  a2 etg  ett

scalar c1 = @coef(2)= -0.15115
gt  b1 xt  b2ett  etg
scalar c2 = @coef(3)= 0.200726
xt  c1tt  c2 gt  etx
matrix(3,3) pata
matrix(3,3) patb
pata.fill(by=r) 1,0, -a1,0,1,0, -c1,-c2,1
patb.fill(by=r) 1,0,0,na,1,0,0,0,1

 1 0 a1   utt   1 0 0  ett 

 0   g    g
 1 0  ut   b2 1 0 et 
 c1 c2 1   utx   0 0 1   etx 

16
 2.1 Blanchard and Perotti (2002)
SPENDING SHOCK

scalar a1 = 2.08 gt  b1 xt  b2ett  etg

scalar c1 = @coef(2)= -0.15115 tt  a1 xt  a2etg  ett
scalar c2 = @coef(3)= 0.200726
xt  c1tt  c2 gt  etx
matrix(3,3) pata
matrix(3,3) patb
pata.fill(by=r) 1,0,0,0,1,-a1, -c2,-c1,1
patb.fill(by=r) 1,0,0,na,1,0,0,0,1

 1 0 0  utg   1 0 0 etg 
 0   t    t
 1 a1   ut    a2 1 0  et 
 c2 c1 1   utx   0 0 1   etx 

17
 2.1 Blanchard and Perotti (2002)
Fig V Response to a Spending Shock
2.50 2.50 2.50

2.00 2.00 2.00

1.50 1.50 1.50

1.00 1.00 1.00

0.50 0.50 0.50

0.00 0.00 0.00

-0.50 -0.50 -0.50

-1.00 -1.00 -1.00

5 10 15 20 5 10 15 20 5 10 15 20

Resp of SPE Resp of TAX Resp of GDP

Fig III Response to a Tax Shock

1.00 1.00 1.00
0.75 0.75 0.75
0.50 0.50 0.50
0.25 0.25 0.25
0.00 0.00 0.00
-0.25 -0.25 -0.25
-0.50 -0.50 -0.50
-0.75 -0.75 -0.75
-1.00 -1.00 -1.00
-1.25 -1.25 -1.25
-1.50 -1.50 -1.50
-1.75 -1.75 -1.75
-2.00 -2.00 -2.00
5 10 15 20 5 10 15 20 5 10 15 20

Resp of TAX Resp of SPE Resp of GDP 18

 3.1 Galí(QJE,1992):short and long
• The purpose was to assess the empirical validity of the IS-
LM model predictions.
• He estimates a VAR from1955:I until 1987:III with four lags.
• Log of GNP (y), at 1982 prices, three month Treasury bills
(i), log of Consumer price index (p) and log of M1.
• After some unit root tests, the variables actually used in the
VAR are: x  [y, i, i  p, m  p]'
shocks   [ s ,  ms ,  md ,  is ]'
• The identification relies on long and short-run restrictions:
• Long-run restrictions
R1: no long-run effects of money supply shocks on y.
R1: no long-run effects of money demand shocks on y.
R3: no long-run effects of IS shocks on y. 19
 3.1 Galí(QJE,1992):short and long
• Short-run restrictions
R4: no contemporaneous effect of money supply shocks on y.
R5: no contemporaneous effect of money demand shocks on y.
R6: Contemporaneous prices do not enter the money supply rule.
Implementation:

E11 (1)S12  E12 (1)S22  E13 (1) S32  E14 (1) S42  0
E11 (1)S14  E12 (1)S24  E13 (1) S34  E14 (1) S44  0
E11 (1) S13  E12 (1) S23  E13 (1) S33  E14 (1) S43  0
S12  0 S13  0
A23 (0)  A24 (0)  0
20
 3.1 Galí(QJE,1992):short and long
1
• Since S = A(0) the last restriction amounts to a nonlinear
restriction on the elements of S.

E11 (1)S12  E12 (1)S22  E13 (1) S32  E14 (1) S42  0
E11 (1)S14  E12 (1)S24  E13 (1) S34  E14 (1) S44  0
E11 (1) S13  E12 (1) S23  E13 (1) S33  E14 (1) S43  0
S12  0 S13  0
A23 (0)  A24 (0)  0
21
 3.1 Galí(QJE,1992):short and long
• Supply Shock
VA1 VA2

1.5 0.0
1.3 -0.4
1.1
-0.8
0.9
0.7 -1.2
0.5 -1.6
5 10 15 20 25 30 5 10 15 20 25 30
GNP INFLATION
VA3 VA4

.8
8
.4
6
.0 4
-.4 2
-.8 0
5 10 15 20 25 30 5 10 15 20 25 30
NOMINAL RATE REAL BALANCES
VA5 VA6

0.8 0.8
0.4 0.4
0.0 0.0
-0.4 -0.4
5 10 15 20 25 30 5 10 15 20 25
M1 GROWTH REAL RATE

Figure I
Dynamic Response to a Supply Shock 22
 4.1 Blanchard and Quah (1988)
• VAR with long-run restrictions.
• They interpret fluctuations in GNP and unemployment as
due to two types of disturbances:
• Supply disturbances, which have permanent effect on GNP.
• Demand disturbances, which only have a temporary effect.
• Estimation of a two-variable VAR: GNP and Unemployment
{∆y,u}‘ with 8 lags from 1950:2 through 1987:4.
• They assume that the level of unemployment and the first
difference of GNP are stationary.
• They use quarterly real GNP at 1982 US dollars and montly
seasonally adjusted unemployment rate for males age 20
and over. Unemployment is averaged over the quarter.
• I got them from FRED. 23
 4.1 Blanchard and Quah (1988)
• Postwar U.S. data suggest a trend in unemployment and a
break in output growth starting in 1974:1.
• In the base case, sample means for each subperiod were
removed from GNP growth. Also,they remove the fitted
linear trend from unemployment.

• BQvar.cleartext(svar)
BQvar.append(svar) @lr1(@u1)=0 'Demand, no long-run effect on GNP
BQvar.svar(rtype=text,conv=1e-5)

utY   0 na  etd 
 U    s
 ut   na na   et 
24
 4.1 Blanchard and Quah (1988)
• VAR with long-run restrictions

Fig 1: Responses to Demand Fig 2: Responses to Supply

1.6 1.0

1.2 0.8

0.8 0.6

0.4 0.4

0.0 0.2

-0.4 0.0

-0.8 -0.2
5 10 15 20 25 30 35 40 5 10 15 20 25 30 35 40

Output response to demand Output response to supply

Unemployment response to demand Unemployment response to supply

25
 4.1 Blanchard and Quah (1988)
Bootstrap 66% Confidence Bounds Bootstrap 66% Confidence Bounds (Levels)
Resp Y to Demand Shocks Resp U to Demand Shocks
1.4 0.1

1.2 0.0

1.0 -0.1

-0.2
0.8

-0.3
0.6
-0.4
0.4
-0.5
0.2
-0.6
0.0
-0.7
-0.2 5 10 15 20 25 30 35 40
5 10 15 20 25 30 35 40

Resp Y to Supply Shocks

1.2 Resp U to Supply Shocks
0.4

0.8 0.3

0.2
0.4
0.1

0.0 0.0

-0.1
-0.4
-0.2

-0.8 -0.3
5 10 15 20 25 30 35 40 5 10 15 20 25 30 35 40 26
 4.1 Blanchard and Quah (1988)
• Variance decomposition:
Variance Decomposition of DYA:
Period S.E. Shock1 Shock2

1 0.962942 97.86411 2.135888

2 1.000325 96.89895 3.101045
3 1.035181 92.34485 7.655154
4 1.049047 90.48098 9.519020
5 1.090383 86.98999 13.01001
6 1.119963 85.57042 14.42958
7 1.132954 84.33290 15.66710
8 1.134462 84.17741 15.82259
9 1.138161 84.27268 15.72732
10 1.145443 84.31336 15.68664
11 1.151488 84.29180 15.70820
12 1.156442 84.21142 15.78858
13 1.157808 84.16146 15.83854
14 1.158376 84.10212 15.89788
15 1.158722 84.06235 15.93765

27
 References
• Bernanke, B. and I. Mihov (1998). ―Measuring monetary policy,‖
Quarterly Journal of Economics CXIII, 315-34.
• Blanchard, O.and D. Quah (1989). ―The dynamic effects of aggregate
demand and supply disturbances.‖ AER pp. 655-73.
• Blanchard, O. R. Perotti (2002). ―An empirical characterization of the
dynamic effects of changes in government spending and taxes on
output.‖ The Quarterly Journal of Economics, pp. 1329-68.
• Christiano, L. , M. Eichenbaum, M (1992). ―Liquidity effects and the
monetary transmission mechanism.‖ AER 82 pp.346-53.
• Christiano, L , M. Eichenbaum and C. Evans (1998). ―Monetary policy
shocks: what have we learned and to what end?‖ Handbook of
Macroeconomics in J. Taylor and M. Woodford (ed.) 82 pp.346-53.

28
 References
• Cushman, D. and T. Zha (1997). ―Identifying monetary policy in a small
open economy under flexible exchange rates.‖ Journal of Monetary
Economics,39 pp.433-48.
• Eichenbaum, M (1992). Comments on ―Interpreting the macroeconomic
time series facts: The effects of monetary policy.‖ European Economic
Review, pp.1001-11.
• Enders, W. (2010). Applied econometric time series Wiley and Sons 3rd
edition.
• Favero, C. (2001) Applied Macroeconometrics. Oxford University Press.
• Gali, J. (1992), "How Well Does the ISLM Model Fit Postwar
Data?" Quarterly Journal of Economics 107, 709-735
• Hamilton, J. (1994) Time Series Analysis. Princeton University Press.

29
 References
• Kim and Roubini, N. (199 ). ―Liquidity and exchange rates in the G-7
countries: evidence from identified VAR‘s.‖ Working Paper Yale
University.
• Lutkepol (2007) ―Econometric Analysis with Vector Autoregressive
Models.‖ European University Institute WP Eco 2007/11.
• Sims, C. (1992) Interpreting the macroeconomic time series facts: The
effects of monetary policy European Economic Review, pp.975-1000.
• Stock and Watson (2001), ―Vector autoregressions.‖ Journal of
Economic Perspectives, 15(4).

30
 TP5 Vectores Autoregresivos

Instituto de Capacitación del FMI

Diciembre 2013

Jorge Restrepo
Curso de Pronostico Macroeconoomico
BTC13.12

31
 Inverse Matrix
• The inverse of B is equal to: 1
 Adjunct of B
|B |

• Further recall that the adjunct matrix is equal to the transpose of the
cofactor matrix.
• Find the inverse of the following matrix:

 1 0  1[(1  )  (1 0)]

B   0 1 0 
its determinant is:
0[(0   )  (1 0)]
 1 1   ( )  [(0 1)  (11)]
  
32
 Inverse Matrix
 1 0 
• The cofactor matrix of B   0 1 0 
 1 1  
is:

 1 0 0 0 0 1
   
 1  1  1 0
 0   0 1
 
   1
1 1 0
  
 1  1  1 1 
    0 1 
 0  1  1 0 
 
 1 0 0 0 0 1 

33
 Inverse Matrix
 0 1
• Cofactor matrix   
 1
  0 1 

   
• Transpose of cofactors:
0   0 

 1 1 1 

   
1 
0 
• Inverse of B: 1
adjB  0   
B   
 1 1 1 
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 Inverse Matrix
• Inverse of B

    
        

1    
B  0 0 
   
 1 1 1 
        


35