Time-Varying Effects of External Shocks on Macroeconomic Fluctuations in Peru: An Empirical Application using TVP-VAR-SV Models

Abstract

This study uses a family of VAR models with time-varying parameters and stochastic volatility (TVP-VAR-SV) to analyze the impact of external shocks on output growth and inflation in Peru in 1992Q1-2017Q1. The statistical relevance of the models is assessed using the deviance information criterion (DIC) and the marginal log-likelihood calculated using the cross-entropy method. The results show that: (i) it is more relevant to introduce SV than TVP; i.e., the best fitting model admits only varying intercepts and SV; and TVP-VAR and CVAR are the least performing models; (ii) the models’ impulse response functions indicate that the impacts from external shocks are different under high inflation, economic crisis, and monetary policy change, with a greater impact in episodes of high uncertainty; (iii) the impact and importance of external shocks have increased over time; and (iv) the results are robust to changes in the priors, the lag structure, order of the variables, the choice of the external variable, and the selection of the variable for domestic economic activity.