CO-INTEGRATING VAR MODELS AND ECONOMIC POLICY

This paper surveys some relevant contributions to the economic literature on co-integrating vector autoregressive (VAR) models [vector error correction mechanisms (VECMs)], emphasizing their usefulness for economic policy. It further discusses some theoretical aspects that are necessary for a complete understanding of their potential. The theoretical introduction of the co-integrating VAR model is followed by an illustration of its applications to monetary policy, fiscal policy and exchanges rates as well as in establishing the effects of structural bilateral shocks between countries (the so-called global VAR, or GVAR, models). Special attention is paid to the VECM capacities of being used in conjunction with dynamic stochastic general equilibrium models and of jointly specifying the short- and long-run dynamics, thus representing the steady-state of economic systems (by means of the co-integration relations) and the short-run dynamics around it.