We are grateful to John Rogers, Ken West, two anonymous referees, seminar participants at the JMCB/Fed Conference on “International Influences on Domestic Prices,” the CCBS Conference on “New Developments in Dynamic Factor Modeling,” and especially to our discussants, Marc Giannoni and Thomas Laubach, for very useful comments and suggestions. The views expressed in this work are those of the authors and do not necessarily reflect those of the Bank of England or the Monetary Policy Committee.
The Transmission of International Shocks: A Factor-Augmented VAR Approach
Article first published online: 22 JAN 2009
© 2009 Crown Copyright
Journal of Money, Credit and Banking
Volume 41, Issue Supplement s1, pages 71–100, February 2009
How to Cite
MUMTAZ, H. and SURICO, P. (2009), The Transmission of International Shocks: A Factor-Augmented VAR Approach. Journal of Money, Credit and Banking, 41: 71–100. doi: 10.1111/j.1538-4616.2008.00199.x
- Issue published online: 22 JAN 2009
- Article first published online: 22 JAN 2009
- Received October 31, 2007; and accepted in revised form July 23, 2008.
- international transmission;
- open economy anomalies;
- large information;
The empirical literature on the transmission of international shocks is based on small-scale VARs. In this paper, we use a large panel of data for 17 industrialized countries to investigate the international transmission mechanism, and revisit the anomalies that arise in the empirical literature. We propose a factor augmented VAR (FAVAR) that extends the model in Bernanke, Boivin, and Eliasz (2005) to the open economy. The main results can be summarized as follows. First, the dynamic effects on the UK economy of an unanticipated fall of short-term interest rates in the rest of the world are: real house price inflation, investment, GDP and consumption growth peak after 1 year, wages peak after 2 years, and CPI and GDP deflator inflation peak during the third year. Second, a positive international supply shock makes the distribution of the components of the UK consumption deflator negatively skewed. Third, in response to a domestic monetary shock, we find little evidence of the exchange rate and liquidity puzzles and little evidence of the forward discount and price anomalies.