A Framework for Structural and Dynamic Analysis in Cointegrated Systems

Abstract

In recent years considerable effort has been focused on the link between shocks that impact the macroeconomy through time and the importance of these shocks in understanding aggregate behavior. As a result empirical research has been directed at disclosing the identity of fundamental structures that adequately described the behavior of the macro economy. To that end. many empiricists embraced the VAR methodology popularized in the work of Sims (1980) and others. This approach assumes that the dynamic behavior of the economy is indeed determined by fundamental structural innovations. The identity of these innovations is ascertained by expressing a vector process in a Wold representation and conducting “structural innovations analysis.” This consists of an examination of the response patterns of certain variables to innovations associated with the Wold structure. The relative importance of the innovations is ascertained by measuring the proportion of forecast error variance that is attributable to each structural innovation.