Modelling Large Open Economies With International Linkages: The Usa and Euro Area

Abstract

SUMMARY Empirical modelling of the linkages between the euro area and the USA requires an open economy framework. The methodology proposed in this paper achieves identification of a structural vector error correction model by supplementing restrictions from economic theory with assumptions for the direction of causality in cross‐country contemporaneous relationships. Our baseline model assumes contemporaneous causality runs from the USA to the euro area for both output and inflation, with monetary policy domestically focused. The role of the USA as leading the euro area business cycle is reinforced by our results, but strong bidirectional cross‐country interactions are uncovered for inflation and interest rates. Copyright © 2013 John Wiley & Sons, Ltd.

International Transmissions to Australia: The Roles of the USA and Euro Area

“…For example, the USA may be considered causally prior to the Euro area for output, but the reverse assumption could be made for inflation. Although Dungey and Osborn () entertain the latter possibility in their model, they find that this does not substantively affect the results, and hence we adopt their baseline case with the USA causally prior to the Euro area within both the output and inflation blocks. Together with an exogeneity assumption for Australia in respect of both of these large economies, and are both lower triangular.…”

“…This SVECM framework is used by Dungey and Osborn () to loosen the exogeneity assumption in the context of modelling interactions between two large economies. Rather than the country‐by‐country identification scheme typically used in the open economy VAR literature (for example, Cushman & Zha, ), they propose a variable‐by‐variable scheme, which restricts the direction of only contemporaneous relationships between key variables for the USA and Euro area.…”

“…In the light of the important bidirectional interactions between the USA and the Euro area shown by Dungey and Osborn (), this paper investigates whether shocks originating in these two major international economies have distinctive roles for Australia. Considering the relative sizes of the economies, Australia is treated as a small open economy with no feedback to either the USA or the Euro area, but variables in both of these are allowed to influence Australia, potentially in distinctive ways.…”

“…As will be discussed in the next section, and based on economic considerations, additional restrictions are imposed on the sub‐matrices and , for ℓ = 0 and ℓ > 0, namely in the interest rate and exchange rate blocks. Indeed, as in Dungey and Pagan () and Dungey and Osborn (), we impose additional restrictions in other sub‐matrices (see subsection and Appendix I), for coherence with economic arguments. The resulting model therefore imposes restrictions based on well‐grounded economic arguments, but the specification is not restricted as closely as recent New Keynesian structural models for Australia that require Bayesian estimation techniques, including Buncic and Melecky (), Nimark () and Leu (), Jääskelä and Nimark ().…”

The influences of international output shocks from the US and China on ASEAN economies

“…Further work is required to specifically incorporate both the US and China as external influences, while also accounting for the long and short run relationships between the domestic and international data. An extension of the proposal in Dungey and Osborn (2014), which interacts the US and Euro Area, may provide a suitable baseline for effectively modelling international conditions which jointly effect Asian economies.…”