Time evolution of external shocks on macroeconomic fluctuations in Pacific Alliance countries: empirical application using TVP-VAR-SV models

Abstract

This article provides empirical evidence on the evolution of the impact of external shocks on the macroeconomic dynamics of the Pacific Alliance (PA) countries. For this purpose, we estimate a family of VAR models that allows time variation (or constancy) of parameters, including the variance matrix (TVP-VAR-SV). The results suggest that: (i) fluctuations from China create the most significant and persistent responses: a 1% increase in China’s growth raises growth by 0.3%-0.4% during the first year in Chile, Colombia, and Mexico; and by 0.8% in Peru; (ii) responses to export price shocks evolve considerably over time; e.g., the impact on growth in Chile and Peru tripled in 1994-2009 and then moderated until 2019; and (iii) unexpected Fed rate increases result in significant increases in AP countries’ monetary policy rates, an effect that escalates during crisis periods and further deepens the negative impact on domestic output growth. Additionally, variance decomposition shows that external factors explained over 50% of deviations in the domestic variables considered in this work. In particular, the results show that external shock absorption over the sample is higher in Mexico and Peru. In contrast, the change in domestic dynamics in absence of external disturbances would have been milder in Chile and Colombia. Finally, we perform four robustness exercises, which imply the following modifications to the baseline model: (i) changing priors; (ii) modifying two external variables; (iii) using lowdimensional models (4, 5, and 6 variables); and (iv) expanding the model by adding a fiscal policy variable. The results do not change significantly relative to those found using the baseline model.