Structural VAR Modelling: of Monetary Policy For Small Open Economies

Structural VAR Modelling
Of Monetary Policy
For Small Open Economies:
The Turkish Case
Agata STĘPIEŃ
Bilge Kagan OZDEMIR
Renata SADOWSKA
Winfield TURPIN
Introduction
VAR methodology:
i. Produces efficient results for small closed

economies
ii. Provides uncertain empirical results for small
open economies
- on account of the effects of monetary policy shocks -
AIM: to present why SVAR
methodology is better than VAR
We investigate the utility

of the structural VAR approach in
conventional empirical puzzles:
i. The price puzzle

ii. The liquidity puzzle
iii. The exchange rate puzzle
Empirical Puzzles
• Result from the recursive structure implied by the

standard identification procedure of VAR models
• Non-recursive identification schemes effectively
solve these puzzles:
Non-recursive VAR’s are called structural VAR (SVAR) models.
Price Puzzle
Sims (1992)
In various empirical VAR studies, a contractionary

monetary shock causes a persistent increase in
price level rather than a decrease.
This odd response of the price level to a
restrictive monetary policy shock is called “the
price puzzle”
The Liquidity Puzzle
Leeper & Gordon (1992)
A similar anomaly has been observed in the

response of interest rates to a shock to
monetary aggregates. Following an
expansionary shock to the money variable,
the interest rate exhibits a positive response
creating “the liquidity puzzle”.
The Exchange Rate Puzzle
Grilli and Roubini (1995) & Sims (1992)
In an open economy environment a

positive innovation in interest rates seems
to result in a depreciation of the local
currency rather than an appreciation. This is
“the exchange rate puzzle”.
The data
All of our estimations use monthly data for Turkey covering the period 1997:1
to 2004:12
IPI : Industrial production index

P : Wholesale price index
M : Monetary aggregate (M1)
R : Short-term interest rates (overnight rates)
REDEX : Real effective exchange rate index
EX : Nominal exchange rate
All variables are in logarithm levels except the short-term rate.

Structural VAR methodology
Structural VAR methodology
• pth order reduced form VAR:

y t  A1 y t 1  ........  A p y t  k  et
yt - n x 1 vector of endogenous variables
Ai - the coefficient vector of lagged variables yt - p
et - the vector of serially uncorrelated reduced form errors
with (etet`) = Σ
• the more compact form:
A( L) y t  et
A(L) - a matrix polynomial in the lag operator L
the structural form of VAR:
B( L) y t  u t
where:
B(L) - a pth order matrix polynomial in the lag operator
B ( L)  B0  B1 L  B2 L2  ...  B P LP
ut - nx1 vector of structural innovations, with:
 
E u t u t'  
ut – serially uncorrelated and diagonal
• The relationship between the structural and the reduced

model
B0A(L)=B(L)
B0e=u
Σ=(B0-1)Ω(B0-1)
Imposing parameter restictions
Cholesky decomposition - orthogonalizing the covariance

matrix of reduced form residuals 
- gives an exactly identified system,
- implies a recursive structure among the variables of the
system.
structural VAR
- allows us to use a non-recursive structure
- we identify the model by imposing short-run restrictions on
B0, or long-run restrictions on B1
Kim and Roubini (2000): indentification = at least n(n+1)/2

restrictions on B0
Determining the set of restrictions on B0
2 approaches:
(i) an explicit macroeconomic model (Gal (1992))
(ii) choosing restrictions based on the structure of the

economy ((Leeper et al. (1996) and Kim and Roubini
(2000)).
- restrictions, which produce the results consistent with

economic theories,
- restrictions, which are not rejected by data.
VAR MODEL
Lag order selection
. varsoc R lIPI lOP lM lP lREDEX

Selection order criteria
Sample: 1997m5 2004m12 Number of obs = 92
+---------------------------------------------------------------------------+
|lag | LL LR df p FPE AIC HQIC SBIC |
|----+----------------------------------------------------------------------|
| 0 | -144.842 1.1e-06 3.27918 3.34556 3.44364 |
| 1 | 560.092 1409.9 36 0.000 5.2e-13 -11.2629 -10.7982* -10.1116* |
| 2 | 613.131 106.08 36 0.000 3.6e-13 -11.6333 -10.7703 -9.49523 |
| 3 | 653.409 80.557 36 0.000 3.4e-13* -11.7263 -10.4651 -8.60145 |
| 4 | 689.552 72.286* 36 0.000 3.5e-13 -11.7294* -10.0699 -7.61777 |
+---------------------------------------------------------------------------+
Endogenous: R lIPI lOP lM lP lREDEX
Exogenous: _cons
FPE - the final prediction error,

AIC - Akaike's information criterion,
BIC - the Bayesian information criterion,
HQIC - the Hannan and Quinn information criterion
VAR model - results
. var R lIPI lOP lM lP lREDEX, lag(1/3)

Vector autoregression

Sample: 1997m4 2004m12 No. of obs = 93
Log likelihood = 661.0898 AIC = -11.76537
FPE = 3.24e-13 HQIC = -10.51187
Det(Sigma_ml) = 2.70e-14 SBIC = -8.660894

Equation Parms RMSE R-sq chi2 P>chi2
----------------------------------------------------------------
R 19 13.2301 0.6380 163.8826 0.0000
lIPI 19 .061535 0.7297 251.0798 0.0000
lOP 19 .035396 0.9984 59819.36 0.0000
lM 19 .064749 0.9967 28285.83 0.0000
lP 19 .011552 0.9998 586895.1 0.0000
lREDEX 19 .033824 0.9253 1152.253 0.0000
----------------------------------------------------------------
------------------------------------------------------------------------------
| Coef. Std. Err. z P>|z| [95% Conf. Interval]
-------------+----------------------------------------------------------------
R |
R |
L1 | .3995304 .1014779 3.94 0.000 .2006374 .5984235
L2 | .1809653 .1187785 1.52 0.128 -.0518363 .4137668
L3 | .15915 .118526 1.34 0.179 -.0731568 .3914567
lIPI |
L1 | 13.37996 21.50408 0.62 0.534 -28.76726 55.52718
L2 | 6.803307 20.3533 0.33 0.738 -33.08843 46.69504
L3 | -19.84411 19.33525 -1.03 0.305 -57.74049 18.05228
lOP |
L1 | 13.18471 74.09397 0.18 0.859 -132.0368 158.4062
L2 | -3.072712 111.4021 -0.03 0.978 -221.4168 215.2713
L3 | 1.81071 79.20603 0.02 0.982 -153.4302 157.0517
lM |
L1 | -30.20778 19.80261 -1.53 0.127 -69.02018 8.60462
L2 | -18.16114 21.20074 -0.86 0.392 -59.71382 23.39154
(-) L3 | 57.92457 19.6259 2.95 0.003 19.45851 96.39063
lP |
L1 | -65.59419 125.1523 -0.52 0.600 -310.8882 179.6998
L2 | .4824675 193.7531 0.00 0.998 -379.2667 380.2316
L3 | 38.10159 114.4841 0.33 0.739 -186.2831 262.4863
lREDEX |
L1 | 24.63748 72.7621 0.34 0.735 -117.9736 167.2486
L2 | -52.32018 110.568 -0.47 0.636 -269.0294 164.389
L3 | 10.48087 74.28239 0.14 0.888 -135.1099 156.0717
_cons | 233.4477 159.4269 1.46 0.143 -79.02332 545.9188
-------------+----------------------------------------------------------------
lIPI |
R |
L1 | -.0011091 .000472 -2.35 0.019 -.0020341 -.000184
L2 | -.0010219 .0005525 -1.85 0.064 -.0021047 .0000609
L3 | -.0000996 .0005513 -0.18 0.857 -.00118 .0009809
lIPI |
L1 | .2043341 .1000175 2.04 0.041 .0083033 .4003649
L2 | .2637963 .0946652 2.79 0.005 .078256 .4493366
L3 | -.1599971 .0899301 -1.78 0.075 -.3362569 .0162626
lOP |
L1 | .1363438 .3446182 0.40 0.692 -.5390954 .811783
L2 | -.0293313 .5181417 -0.06 0.955 -1.04487 .9862078
L3 | -.4743676 .3683948 -1.29 0.198 -1.196408 .247673
lM |
L1 | -.2818191 .0921038 -3.06 0.002 -.4623393 -.1012989
L2 | -.0029148 .0986067 -0.03 0.976 -.1961804 .1903507
L3 | .1458815 .091282 1.60 0.110 -.0330278 .3247909
lP |
L1 | -.4241252 .5820954 -0.73 0.466 -1.565011 .7167609
L2 | .6964245 .9011644 0.77 0.440 -1.069825 2.462674
L3 | .2978765 .5324765 0.56 0.576 -.7457583 1.341511
lREDEX |
L1 | -.117054 .3384235 -0.35 0.729 -.7803519 .5462439
L2 | .0968535 .5142622 0.19 0.851 -.9110818 1.104789
L3 | -.3506112 .3454945 -1.01 0.310 -1.027768 .3265457
lOP |
R |
L1 | .0011678 .0002715 4.30 0.000 .0006356 .0016999
L2 | -.0008104 .0003178 -2.55 0.011 -.0014332 -.0001875
L3 | .0011107 .0003171 3.50 0.000 .0004892 .0017323
lIPI |
L1 | .012352 .057532 0.21 0.830 -.1004087 .1251127
L2 | -.0109391 .0544533 -0.20 0.841 -.1176655 .0957873
L3 | -.0732841 .0517295 -1.42 0.157 -.1746721 .028104
lOP |
L1 | 1.333208 .1982311 6.73 0.000 .9446823 1.721734
L2 | -.9057044 .2980452 -3.04 0.002 -1.489862 -.3215465
L3 | .6686133 .2119079 3.16 0.002 .2532815 1.083945
lM |
L1 | .0881565 .0529799 1.66 0.096 -.0156822 .1919953
L2 | .0251405 .0567205 0.44 0.658 -.0860296 .1363106
L3 | .0643267 .0525072 1.23 0.221 -.0385855 .1672388
lP |
L1 | -.4812317 .3348327 -1.44 0.151 -1.137492 .1750283
L2 | .79044 .5183674 1.52 0.127 -.2255415 1.806421
L3 | -.6453991 .3062909 -2.11 0.035 -1.245718 -.0450799
lREDEX |
L1 | -.1132399 .1946678 -0.58 0.561 -.4947818 .268302
L2 | -.0643379 .2958137 -0.22 0.828 -.644122 .5154462
L3 | .4465974 .1987352 2.25 0.025 .0570836 .8361113
lM |
R |
L1 | -.0002212 .0004966 -0.45 0.656 -.0011946 .0007522
L2 | .0004955 .0005813 0.85 0.394 -.0006438 .0016349
L3 | -.0000379 .0005801 -0.07 0.948 -.0011748 .001099
lIPI |
L1 | .1994379 .1052423 1.90 0.058 -.0068332 .405709
L2 | -.1596862 .0996103 -1.60 0.109 -.3549188 .0355464
L3 | .2012161 .0946279 2.13 0.033 .0157488 .3866833
lOP |
L1 | .369864 .3626205 1.02 0.308 -.3408591 1.080587
L2 | .1119453 .5452086 0.21 0.837 -.9566439 1.180535
L3 | -.3698579 .3876392 -0.95 0.340 -1.129617 .389901
lM |
L1 | .4052211 .0969152 4.18 0.000 .2152709 .5951714
L2 | .2263902 .1037577 2.18 0.029 .0230288 .4297516
L3 | .2045462 .0960504 2.13 0.033 .0162909 .3928015
lP |
L1 | -.8188753 .6125032 -1.34 0.181 -2.01936 .3816089
L2 | 1.453369 .9482399 1.53 0.125 -.4051467 3.311885
L3 | -.5771145 .5602923 -1.03 0.303 -1.675267 .5210382
lREDEX |
L1 | .2498104 .3561022 0.70 0.483 -.4481371 .947758
L2 | .1801751 .5411264 0.33 0.739 -.8804131 1.240763
L3 | -.160013 .3635426 -0.44 0.660 -.8725434 .5525175
lP |
R |
L1 | .0002657 .0000886 3.00 0.003 .0000921 .0004394
L2 | -.0002623 .0001037 -2.53 0.011 -.0004655 -.000059
L3 | .000144 .0001035 1.39 0.164 -.0000588 .0003468
lIPI |
L1 | -.0203368 .0187759 -1.08 0.279 -.0571368 .0164632
L2 | -.0050536 .0177711 -0.28 0.776 -.0398843 .029777
L3 | -.0010808 .0168822 -0.06 0.949 -.0341693 .0320077
lOP |
L1 | .2226912 .0646937 3.44 0.001 .095894 .3494885
L2 | -.3624083 .0972685 -3.73 0.000 -.553051 -.1717656
L3 | .1525029 .0691571 2.21 0.027 .0169573 .2880484
lM |
(-) L1 | .0503055 .0172902 2.91 0.004 .0164172 .0841938
L2 | -.0221363 .018511 -1.20 0.232 -.0584172 .0141445
L3 | .0114683 .017136 0.67 0.503 -.0221175 .0450542
lP |
L1 | 1.338255 .1092742 12.25 0.000 1.124081 1.552429
L2 | -.3782558 .1691716 -2.24 0.025 -.7098261 -.0466855
L3 | -.0231389 .0999595 -0.23 0.817 -.2190559 .172778
lREDEX |
L1 | .0515253 .0635308 0.81 0.417 -.0729927 .1760433
L2 | -.0944245 .0965402 -0.98 0.328 -.2836398 .0947907
L3 | .0192958 .0648582 0.30 0.766 -.1078238 .1464155
lREDEX |
R |
(+) L1 | -.0010795 .0002594 -4.16 0.000 -.001588 -.000571
L2 | .0006899 .0003037 2.27 0.023 .0000948 .0012851
L3 | -.0009764 .000303 -3.22 0.001 -.0015703 -.0003825
lIPI |
L1 | -.0380951 .0549767 -0.69 0.488 -.1458476 .0696573
L2 | -.0258617 .0520347 -0.50 0.619 -.1278478 .0761244
L3 | .1137401 .049432 2.30 0.021 .0168552 .210625
lOP |
L1 | -.0400498 .1894266 -0.21 0.833 -.4113191 .3312195
L2 | .3524744 .2848075 1.24 0.216 -.2057379 .9106868
L3 | -.3852534 .2024959 -1.90 0.057 -.7821382 .0116313
lM |
L1 | -.0514458 .0506268 -1.02 0.310 -.1506725 .0477809
L2 | -.0421617 .0542012 -0.78 0.437 -.1483941 .0640707
L3 | -.039677 .050175 -0.79 0.429 -.1380183 .0586643
lP |
L1 | .6439002 .319961 2.01 0.044 .0167882 1.271012
L2 | -.8925327 .4953439 -1.80 0.072 -1.863389 .0783236
L3 | .4943425 .2926869 1.69 0.091 -.0793132 1.067998
lREDEX |
L1 | 1.32148 .1860216 7.10 0.000 .9568841 1.686075
L2 | -.3721302 .282675 -1.32 0.188 -.926163 .1819025
L3 | -.2428434 .1899083 -1.28 0.201 -.6150568 .1293701
. varstable

The stability
Eigenvalue stability condition
+----------------------------------------+
| Eigenvalue | Modulus |
of the model
|--------------------------+-------------|
| .9941794 + .0143843i | .994283 |
| .9941794 - .0143843i | .994283 |
| .8836465 + .1336579i | .893698 |
| .8836465 - .1336579i | .893698 |
| .6276038 + .4060743i | .747518 |
| .6276038 - .4060743i | .747518 |
| -.3011287 + .5766123i | .650508 |
| -.3011287 - .5766123i | .650508 |
| -.6301265 | .630126 |
| .6223038 | .622304 |
| .3939734 + .4414872i | .591714 |
| .3939734 - .4414872i | .591714 |
| .1893117 + .5121128i | .545984 |
| .1893117 - .5121128i | .545984 |
| -.2825017 + .3782144i | .472073 |
| -.2825017 - .3782144i | .472073 |
| -.0001588 + .3392226i | .339223 |
| -.0001588 - .3392226i | .339223 |
+----------------------------------------+
All the eigenvalues lie inside the unit
circle
VAR satisfies stability condition
Lagrange Multiplier test for
autocorrelation in the
residuals of VAR model
. varlmar

Lagrange-multiplier test
+--------------------------------------+
| lag | chi2 df Prob > chi2 |
|------+-------------------------------|
| 1 | 50.2262 36 0.05795 |
| 2 | 35.3152 36 0.50097 |
+--------------------------------------+
H0: no autocorrelation at lag order
Impulse-response functions
for VAR model
irf, lIPI, R irf, lIPI, lREDEX
50 .2
-.2
-50
-.4
0 2 4 6 8 0 2 4 6 8
step step
95% CI impulse response function (irf) 95% CI impulse response function (irf)
Graphs by irfname, impulse variable, and response variable Graphs by irfname, impulse variable, and response variable
irf, lP, lREDEX irf, lP, R

3 200
2 0
1
-200
0
-400
0 2 4 6 8 0 2 4 6 8
step step
irf, R, R irf, R, lREDEX
1
0
-.001
.5
-.002
0 -.003
0 2 4 6 8 0 2 4 6 8
step step
irf, lREDEX, R irf, lREDEX, lREDEX

200 2
100
0
-100
-200 -1
0 2 4 6 8
0 2 4 6 8
step step
Graphs by irfname, impulse variable, and response variable
Structural VAR
1st model
Equations: •eOP = 
•eIPI = eOP + 
•eP = eIPI + 
• eR = eOP + eIPI + eREDEX + 
•eREDEX = eOP + eR + 
. svar lOP lIPI lP R lREDEX, aeq(A)
Estimating short-run parameters
Results

Log likelihood = -7512.638
LR test of overidentifying restrictions LR chi2( 8) = 16001.667
Prob > chi2 = 0.0000

--------------------------------------------------------------------------
Equation Obs Parms RMSE R-sq chi2 P
--------------------------------------------------------------------------
lOP 94 11 .038518 0.9980 47749.65 0.0000
lIPI 94 11 .063011 0.6828 202.3791 0.0000
lP 94 11 .012667 0.9998 459943 0.0000
R 94 11 13.2022 0.5966 139.0212 0.0000
lREDEX 94 11 .035579 0.9093 942.5407 0.0000
--------------------------------------------------------------------------

VAR Model lag order selection statistics
----------------------------------------
FPE AIC HQIC SBIC LL Det(Sigma_ml)
6.872e-11 -9.2169243 -8.6158416 -7.7288263 488.19544 2.121e-11

------------------------------------------------------------------------------
-------------+----------------------------------------------------------------
a_2_1 |
_cons | .118268 .1031421 1.15 0.252 -.0838868 .3204229
-------------+----------------------------------------------------------------
a_4_1 |
_cons | -72.5256 .3379927 -214.58 0.000 -73.18806 -71.86315
-------------+----------------------------------------------------------------
a_5_1 |
_cons | -1.369489 .1313077 -10.43 0.000 -1.626847 -1.11213
-------------+----------------------------------------------------------------
a_3_2 |
_cons | .0155035 .1024283 0.15 0.880 -.1852522 .2162592
-------------+----------------------------------------------------------------
a_4_3 |
_cons | 127.3628 .8188706 155.53 0.000 125.7579 128.9678
-------------+----------------------------------------------------------------
a_5_4 |
(+) _cons | .0620754 .0018962 32.74 0.000 .058359 .0657917
-------------+----------------------------------------------------------------
a_4_5 |
_cons | -22.80443 .248202 -91.88 0.000 -23.2909 -22.31796
------------------------------------------------------------------------------
2 nd
model
Equations: •eIPI = eOP + 

•eP = eIPI + 
• eR = eOP + eIPI + eREDEX + 
•eREDEX = eOP + eIPI + eP + eR + 
. svar lOP lIPI lP R lREDEX, aeq(A)
Log likelihood = -7660.8406
Results
LR test of overidentifying restrictions LR chi2( 6) = 16298.072
Prob > chi2 = 0.0000
--------------------------------------------------------------------------
Equation Obs Parms RMSE R-sq chi2 P
--------------------------------------------------------------------------
lOP 94 11 .038518 0.9980 47749.65 0.0000
lIPI 94 11 .063011 0.6828 202.3791 0.0000
lP 94 11 .012667 0.9998 459943 0.0000
R 94 11 13.2022 0.5966 139.0212 0.0000
lREDEX 94 11 .035579 0.9093 942.5407 0.0000
--------------------------------------------------------------------------
----------------------------------------
6.872e-11 -9.2169243 -8.6158416 -7.7288263 488.19544 2.121e-11
------------------------------------------------------------------------------
-------------+----------------------------------------------------------------
a_2_1 |
_cons | 1.01558 .1031421 9.85 0.000 .8134252 1.217735
-------------+----------------------------------------------------------------
a_4_1 |
_cons | 1.251037 .1571423 7.96 0.000 .943044 1.559031
-------------+----------------------------------------------------------------
a_5_1 |
_cons | .4819695 .1485563 3.24 0.001 .1908045 .7731345
-------------+----------------------------------------------------------------
a_3_2 |
_cons | 1.073148 .0723666 14.83 0.000 .9313118 1.214984
-------------+----------------------------------------------------------------
a_5_2 |
_cons | -2.099263 .2086427 -10.06 0.000 -2.508195 -1.690331
-------------+----------------------------------------------------------------
a_4_3 |
_cons | 1.762008 .1202497 14.65 0.000 1.526322 1.997693
-------------+----------------------------------------------------------------
a_5_3 |
_cons | .5360897 .1105982 4.85 0.000 .3193211 .7528582
-------------+----------------------------------------------------------------
a_5_4 |
_cons | -.0125239 .0443363 -0.28 0.778 -.0994214 .0743736
-------------+----------------------------------------------------------------
a_4_5 |
_cons | 1.574081 .0619692 25.40 0.000 1.452623 1.695538
------------------------------------------------------------------------------
for SVAR model
50 .3
.2
.1
0
-.1
-50
0 2 4 6 8 0 2 4 6 8
step step
95% CI irf 95% CI irf

3
100
0
2
-100
-200
0 -300
0 2 4 6 8 0 2 4 6 8
step step
1 .001
.5
-.001
-.002
0
0 2 4 6 8
0 2 4 6 8
step
step
95% CI irf
95% CI irf

200 2
100
1
-100
-200 -1
0 2 4 6 8 0 2 4 6 8
step step
3rd model
Equations: •eIPI = eOP + 

•eP = eOP + eIPI + 
•eM = eP + eR + 
•eR = eOP + eM + eREDEX + 
•eREDEX = eOP + eIPI + eP + eM + eR + 
----------------------------------------
3.598e-13 -11.636792 -10.784347 -9.5263982 624.92921 6.770e-14
Results
------------------------------------------------------------------------------
-------------+----------------------------------------------------------------
a_2_1 |
_cons | .0135702 .1031421 0.13 0.895 -.1885846 .2157251
-------------+----------------------------------------------------------------
a_3_1 |
_cons | -.1462277 .1031516 -1.42 0.156 -.3484012 .0559457
-------------+----------------------------------------------------------------
a_5_1 |
_cons | 39.04031 .3636957 107.34 0.000 38.32748 39.75314
-------------+----------------------------------------------------------------
a_6_1 |
_cons | 2.069827 .1633726 12.67 0.000 1.749622 2.390031
-------------+----------------------------------------------------------------
a_3_2 |
_cons | .0009657 .1031421 0.01 0.993 -.2011892 .2031205
-------------+----------------------------------------------------------------
a_6_2 |
_cons | .1058091 .1034304 1.02 0.306 -.0969108 .3085291
-------------+----------------------------------------------------------------
a_4_3 |
(+) _cons | 1.949205 .2572013 7.58 0.000 1.445099 2.45331
-------------+----------------------------------------------------------------
a_6_3 |
_cons | 20.60607 1.519741 13.56 0.000 17.62744 23.58471
-------------+----------------------------------------------------------------
a_5_4 |
_cons | 34.16626 .0843784 404.92 0.000 34.00088 34.33163
-------------+----------------------------------------------------------------
a_6_4 |
_cons | -15.77592 1.177115 -13.40 0.000 -18.08303 -13.46882
-------------+----------------------------------------------------------------
a_4_5 |
_cons | .0816462 .0058645 13.92 0.000 .070152 .0931405
-------------+----------------------------------------------------------------
a_6_5 |
(+) _cons | -.0073892 .0085119 -0.87 0.385 -.0240723 .0092939
-------------+----------------------------------------------------------------
a_5_6 |
_cons | 113.1403 .9599074 117.87 0.000 111.2589 115.0217
------------------------------------------------------------------------------
for money in SVAR model
irf, lM, lIPI irf, lM, R
.2 40
20
-.2
-20
-40
-.4
0 2 4 6 8 0 2 4 6 8
step step
irf, lM, lP
.3
.2
.1
0
0 2 4 6 8
step
95% CI irf
irf, lM, lM
1
.5
0
0 2 4 6 8
step
95% CI irf
irf, lM, lREDEX
.1
2.776e-17
-.1
-.2
-.3
0 2 4 6 8
step
95% CI irf
CONCLUSIONS
Comparison
of responses functions
for VAR and SVAR models
SVAR responses functions:
50 .3
.2
.1
0
-.1
-50
0 2 4 6 8 0 2 4 6 8
step step
VAR responses functions:

irf, lIPI, R
irf, lIPI, lREDEX
50 .2
-.2
-50
-.4
0 2 4 6 8 0 2 4 6 8
step step
3
100
0
2
-100
-200
0 -300
0 2 4 6 8 0 2 4 6 8
step step

irf, lP, R
irf, lP, lREDEX
200
3
2 0
1
-200
0
-400
0 2 4 6 8 0 2 4 6 8
step step
1 .001
.5
-.001
-.002
0 2 4 6 8 0 2 4 6 8
step step

irf, R, R
irf, R, lREDEX
1
0
-.001
.5
-.002
0 -.003
0 2 4 6 8 0 2 4 6 8
step step
200 2
100
1
-100
-200 -1
0 2 4 6 8 0 2 4 6 8
step step

200 2
100
-100
-200 -1
0 2 4 6 8 0 2 4 6 8
step step
Why SVAR is better than VAR?
VAR MODELS:
• it is often difficult to draw any conclusion from the large number of

coefficient estimates in a VAR system,
• vector autoregressions have the status of „reduced form'' and, thus, are
merely vehicles to summarize the dynamic properties of the data,
• the parameters do not have an economic meaning and are subject
to the so-called „Lucas critique'‘.
SVAR MODELS:
• SVAR’s do not contain fixed-coefficient expectational rules. They

are best thought of as giving linear approximations to the behavior of the
private sector and monetary authorities. The private behavior they model
thus implicitly includes dynamics arising from revision in forecasting
rules as well as other sources of dynamics.

Structural VAR Modelling: of Monetary Policy For Small Open Economies

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Structural VAR Modelling: of Monetary Policy For Small Open Economies

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Structural VAR Modelling

i. Produces efficient results for small closed

We investigate the utility

i. The price puzzle

• Result from the recursive structure implied by the

In various empirical VAR studies, a contractionary

A similar anomaly has been observed in the

In an open economy environment a

IPI : Industrial production index

All variables are in logarithm levels except the short-term rate.

• pth order reduced form VAR:

• The relationship between the structural and the reduced

Cholesky decomposition - orthogonalizing the covariance

Kim and Roubini (2000): indentification = at least n(n+1)/2

(i) an explicit macroeconomic model (Gal (1992))

(ii) choosing restrictions based on the structure of the

- restrictions, which produce the results consistent with

FPE - the final prediction error,

irf, lP, lREDEX irf, lP, R

irf, lREDEX, R irf, lREDEX, lREDEX

Equations: •eIPI = eOP + 

irf, lP, lREDEX irf, lP, R

irf, lREDEX, R irf, lREDEX, lREDEX

Equations: •eIPI = eOP + 

VAR responses functions:

VAR responses functions:

VAR responses functions:

VAR responses functions:

• it is often difficult to draw any conclusion from the large number of

• SVAR’s do not contain fixed-coefficient expectational rules. They

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