-2-
and the results of some tests for structural breaks and some robustness checks. Section 6
finally concludes with some policy recommendations.
2. “Going global” - global variables and a global perspective on shocks
In this paper, we investigate the co-movements among some macro variables across the
G7 and the euro-area countries with the aim to uncover the common driving forces
shaping international macroeconomic dynamics and the features of their transmission
mechanisms. For this purpose, we make use of a modified version of the Stock and
Watson (2005a) Factor-Augmented Vector Autoregression (FAVAR) model. Our
approach allows a more straightforward economic interpretation of the unobservable
global factors. Our work is, on the one hand, related to the literature on global VARs
(GVARs) and, on the other hand, to the research done on international business cycle co-
movement.
2.1 FAVARs, GVARs and international business cycle co-movement
Let us first delineate the notion of a SFAVAR against that of a GVAR model. A GVAR
model is a compact model of the world economy designed to explicitly estimate the
economic and financial interdependencies at national and international levels. Individual
country/region specific vector error-correcting models are estimated, where the domestic
variables are related to corresponding foreign variables constructed exclusively to match
the international trade pattern of the country under consideration. The individual country
models are then linked in a consistent manner so that the GVAR model is solved for the
world as a whole. The degree of regional interdependence is investigated via generalized
impulse response functions that portray the effects of shocks to a given variable in a
given country/market on the rest of the world (Pesaran, Schuermann and Weiner, 2004,
and Dees, di Mauro, Pesaran and Smith, 2007). In our FAVAR, the econometric
approach is less complicated and perhaps more straightforward. All global variables are
modeled as endogenous in a structural VAR context. Spillover effects from global to
national variables are possible, since there is a direct link between the global and the
national level via the factor loadings. Global forces are regarded as exogenous to