Estimating foreign shocks in a VAR model

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07-12-2021
MAKRO

This note describes how foreign shocks are estimated in the work with the MAKRO model.

Abstract

This note describes how foreign shocks are estimated in the work with MAKRO. The foreign block consists of the total export market, foreign prices, the interest rate, and the oil price. Thus, a shock to either foreign variable is now part of an endogenous system - akin to a number of related papers using VAR models, including the literature on spillovers. The problem of identifying multiple shocks is addressed by combining different types of restrictions, including an assumption of Denmark as a small open economy as well as sign restrictions to separately identify foreign demand- and supply-type shocks as well as controlling for generic domestic shocks. This approach leads to results, which are broadly in line with theory and related empirical literature, albeit they are associated with non-negligible uncertainty for some shocks and variables.