International Transmissions of Aggregate Macroeconomic Uncertainty in Small Open Economies

An Empirical Approach

Jamie L. Cross, Aubrey Poon, Chenghan Hou

Research output: Working paper

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Abstract

We estimate the effects of domestic and international sources of macroeconomic uncertainty in three commonly studied small open economies (SOEs): Australia, Canada and New Zealand. To this end, we propose a common stochastic volatility in mean panel VAR (CSVM-PVAR), and develop an efficient Markov chain Monte Carlo algorithm to estimate the model. Using a formal Bayesian model comparison exercise, our in-sample results suggest that foreign uncertainty spillovers shape the macroeconomic conditions in all SOEs, however domestic uncertainty shocks are important for Australia and Canada, but not New Zealand. The general mechanism is that foreign uncertainty shocks reduce real GDP and raise inflation in all SOEs, however the interest rate responses are idiosyncratic; being positive in Australia and New Zealand, and negative in Canada. Conversely, domestic uncertainty shocks tend to raise all three macroeconomic variables. Finally, in a pseudo out-of-sample forecasting exercise, the proposed model also forecasts better than traditional PVAR and CSV-PVAR benchmarks.
Original languageEnglish
Place of PublicationCanberra
Number of pages33
Volume16/2018
Publication statusPublished - 18 Apr 2018

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Macroeconomic uncertainty
Small open economy
Uncertainty
International transmission
Canada
New Zealand
Exercise
Markov chain Monte Carlo
Spillover
Stochastic volatility
Interest rates
Macroeconomic variables
Model comparison
Panel VAR
Benchmark
Bayesian model
Inflation
Real GDP
Out-of-sample forecasting
Macroeconomic conditions

Keywords

  • Bayesian VARs
  • international spillovers
  • state-space models
  • stochastic volatility in mean
  • uncertainty

Cite this

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title = "International Transmissions of Aggregate Macroeconomic Uncertainty in Small Open Economies: An Empirical Approach",
abstract = "We estimate the effects of domestic and international sources of macroeconomic uncertainty in three commonly studied small open economies (SOEs): Australia, Canada and New Zealand. To this end, we propose a common stochastic volatility in mean panel VAR (CSVM-PVAR), and develop an efficient Markov chain Monte Carlo algorithm to estimate the model. Using a formal Bayesian model comparison exercise, our in-sample results suggest that foreign uncertainty spillovers shape the macroeconomic conditions in all SOEs, however domestic uncertainty shocks are important for Australia and Canada, but not New Zealand. The general mechanism is that foreign uncertainty shocks reduce real GDP and raise inflation in all SOEs, however the interest rate responses are idiosyncratic; being positive in Australia and New Zealand, and negative in Canada. Conversely, domestic uncertainty shocks tend to raise all three macroeconomic variables. Finally, in a pseudo out-of-sample forecasting exercise, the proposed model also forecasts better than traditional PVAR and CSV-PVAR benchmarks.",
keywords = "Bayesian VARs, international spillovers, state-space models, stochastic volatility in mean, uncertainty",
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T1 - International Transmissions of Aggregate Macroeconomic Uncertainty in Small Open Economies

T2 - An Empirical Approach

AU - Cross, Jamie L.

AU - Poon, Aubrey

AU - Hou, Chenghan

N1 - CAMA Working Paper 16/2018

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N2 - We estimate the effects of domestic and international sources of macroeconomic uncertainty in three commonly studied small open economies (SOEs): Australia, Canada and New Zealand. To this end, we propose a common stochastic volatility in mean panel VAR (CSVM-PVAR), and develop an efficient Markov chain Monte Carlo algorithm to estimate the model. Using a formal Bayesian model comparison exercise, our in-sample results suggest that foreign uncertainty spillovers shape the macroeconomic conditions in all SOEs, however domestic uncertainty shocks are important for Australia and Canada, but not New Zealand. The general mechanism is that foreign uncertainty shocks reduce real GDP and raise inflation in all SOEs, however the interest rate responses are idiosyncratic; being positive in Australia and New Zealand, and negative in Canada. Conversely, domestic uncertainty shocks tend to raise all three macroeconomic variables. Finally, in a pseudo out-of-sample forecasting exercise, the proposed model also forecasts better than traditional PVAR and CSV-PVAR benchmarks.

AB - We estimate the effects of domestic and international sources of macroeconomic uncertainty in three commonly studied small open economies (SOEs): Australia, Canada and New Zealand. To this end, we propose a common stochastic volatility in mean panel VAR (CSVM-PVAR), and develop an efficient Markov chain Monte Carlo algorithm to estimate the model. Using a formal Bayesian model comparison exercise, our in-sample results suggest that foreign uncertainty spillovers shape the macroeconomic conditions in all SOEs, however domestic uncertainty shocks are important for Australia and Canada, but not New Zealand. The general mechanism is that foreign uncertainty shocks reduce real GDP and raise inflation in all SOEs, however the interest rate responses are idiosyncratic; being positive in Australia and New Zealand, and negative in Canada. Conversely, domestic uncertainty shocks tend to raise all three macroeconomic variables. Finally, in a pseudo out-of-sample forecasting exercise, the proposed model also forecasts better than traditional PVAR and CSV-PVAR benchmarks.

KW - Bayesian VARs

KW - international spillovers

KW - state-space models

KW - stochastic volatility in mean

KW - uncertainty

UR - https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3160394

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