VAR MODEL IN STUDYING MACROECONOMIC SHOCKS: PROBLEMS AND SOLUTIONS

Abstract

Since the introduciton by Sims (1980) and the first application in macroeconomics in 1980, the vector autoregression model VAR has become a standard tool for monetary policy analysis and economic variables forecast for decades. VAR model has become one of the most polular tools in analyzing macroeconomic shocks. Nevertheless, empirical results from VAR are sometimes inconsistent with macroeconomic theory, which requires a detailed examination of VAR to explain those results. By examining a compilation of VAR's results for recent years, our study discovers three problems that could make VAR's results unreliable. Based on abovementioned problems, we recommend some modification to deal with those problems.

Keywords: VAR model, price puzzle, non-fundamental shocks, recursiveness assumption, macroeconomic shocks