MACROECONOMETRIC MODELLING WITH A GLOBAL PERSPECTIVE*

Abstract

This paper provides a synthesis and further development of a global modelling approach introduced in Pesaran et al. (Journal of Business and Economic Statistics, Vol. 22 (2004), pp. 129–162), where country‐specific models in the form of VARX* structures are estimated relating a vector of domestic variables, xit, to their foreign counterparts, , and then consistently combined to form a global vector autoregression. It is shown that the VARX* models can be derived as the solution to a dynamic stochastic general equilibrium model where overidentifying long‐run theoretical relations can be tested and imposed if acceptable. This gives the system a transparent long‐run theoretical structure. Similarly, short‐run overidentifying theoretical restrictions can be tested and imposed if accepted. Alternatively, if one has less confidence in the short‐run theory the dynamics can be left unrestricted. The assumption of the weak exogeneity of the foreign variables for the long‐run parameters can be tested, where variables can be interpreted as proxies for regional and global factors. Rather than using deviations from ad hoc statistical trends, the equilibrium values of the variables reflecting the long‐run theory embodied in the model can be calculated. The paper also provides some new results on the relative importance of external shocks for the UK and the Euro area economies.