International Demand and Liquidity Shocks in a SVAR Model of the Australian Economy

Abstract

A structural vector autoregressive model of the Australian economy that allows for international shocks from the USA, Japan as well as world commodity prices is specified and estimated for the period 1979–1999. A block exogenous structure linking the three countries is imposed. The international linkages are modelled using a factor structure to circumvent problems from estimating large scale dynamic models. The factors are estimated recursively using a Kalman filter and are found to represent aggregate demand and liquidity shocks for the USA and Japan respectively. The key empirical result is the USA shocks are the dominant source of international shocks on the Australian economy with the Japanese economy having a dampening effect on the USA shocks. The empirical results also show that Australian monetary policy responds to domestic conditions rather than international monetary policy.