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The Relative Importance of Symmetric and Asymmetric Shocks: The Case of United Kingdom and Euro Area

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  • This paper was initially written for the Summer at CEU Workshop on ‘Globalization and Real Convergence’, Central European University, Budapest. I thank two anonymous referees, Zsolt Darvas, Ferre De Graeve, Frank Smets and workshop participants for useful comments. All remaining errors are solely mine.

Abstract

We show how a simple model with sign restrictions can be used to identify symmetric and asymmetric supply, demand and monetary policy shocks in an estimated two-country structural VAR for the UK and Euro area. The results can be used to deal with several issues that are relevant in the optimal currency area literature. We find an important role for symmetric shocks in explaining the variability of the business cycle in both economies. However, the relative importance of asymmetric shocks, being around 20% in the long run, cannot be ignored. Moreover, when we estimate the model for the UK and US, the degree of business cycle synchronization seems to be higher. Finally, we confirm existing evidence of the exchange rate being an independent source of shocks in the economy.

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