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A systematic framework for analyzing the dynamic effects of permanent and transitory shocks

✍ Scribed by Jesús Gonzalo; Serena Ng

Publisher
Elsevier Science
Year
2001
Tongue
English
Weight
172 KB
Volume
25
Category
Article
ISSN
0165-1889

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✦ Synopsis

This paper proposes a systematic framework for analyzing the dynamic e!ects of permanent and transitory shocks on a system of n economic variables. We consider a two-step orthogonolization on the residuals of a VECM with r cointegrating vectors. The "rst step separates the permanent from the transitory shocks, and the second step isolates n!r mutually uncorrelated permanent shocks and r transitory shocks. The decomposition is computationally straightforward and entails only a minor modi"cation to the Choleski decomposition commonly used in the literature. We then show how impulse response functions can be constructed to trace out the propagating mechanism of shocks distinguished by their degree of persistence. In an empirical example, the dynamic responses to the identi"ed permanent shocks have properties similar to shocks to productivity, the real interest rate, and money growth, even though no economic

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