External Linkages and Economic Growth in Colombia: Insights from A Bayesian VAR Model

Transcription

1 WP// Exernal Linkages and Economic Growh in Colombia: Insighs from A Bayesian VAR Model Lisandro Abrego and Pär Öserholm

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3 Inernaional Moneary Fund WP// IMF Working Paper Wesern Hemisphere Exernal Linkages and Economic Growh in Colombia: Insighs from A Bayesian VAR Model Prepared by Lisandro Abrego and Pär Öserholm # Auhorized for disribuion by Benedic Clemens February Absrac This Working Paper should no be repored as represening he views of he IMF. The views expressed in his Working Paper are hose of he auhor(s) and do no necessarily represen hose of he IMF or IMF policy. Working Papers describe research in progress by he auhor(s) and are published o elici commens and o furher debae. This paper invesigaes he sensiiviy of Colombian GDP growh o he surrounding macroeconomic environmen. We esimae a Bayesian VAR model wih informaive seady-sae priors for he Colombian economy using quarerly daa from 99 o 7. A variance decomposiion shows ha world GDP growh and governmen spending are he mos imporan facors, explaining roughly 7 and percen of he variance in Colombian GDP growh respecively. The model, which is shown o forecas well ou-of-sample, can also be used o analyse alernaive scenarios. Generaing boh endogenous and condiional forecass, we show ha he impac on Colombian GDP growh of a subsanial downurn in world GDP growh would be non-negligible bu sill a mild decline by hisorical sandards. JEL Classificaion Numbers: C3, F37, F3 Keywords: Bayesian VAR We are graeful o Caroline Akinson, Ben Clemens and seminar paricipans a he Inernaional Moneary Fund and Banco de la República for valuable commens on his paper. Öserholm graefully acknowledges financial suppor from Jan Wallander s and Tom Hedelius Foundaion. Wesern Hemisphere Division, Inernaional Moneary Fund, 7 9h Sree NW, Washingon, DC 3, USA. labrego@imf.org Phone: # Deparmen of Economics, Uppsala Universiy, Box 3, 7 Uppsala, Sweden. par.oserholm@nek.uu.se Phone:

4 Conens I. Inroducion...3 II. The Model... III. Empirical Implemenaion... IV. Resuls...7 A. Impulse Responses and Variance Decomposiion...7 B. Hisorical Decomposiion... C. Ou-of-Sample Forecasing: A Comparison...3 D. Uncondiional and Condiional Forecass... V. Conclusions...9 Tables. 9 Percen Prior Inervals...7 Figures. Daa.... Impulse Response Funcions for Colombia GDP Growh Variance Decomposiion for Colombia GDP Growh.... Foreign and Domesic Facors in -7 Growh.... Forecasing Performance of Alernaive Models (Relaive Mean Square Errors).... Uncondiional Forecas WEO-Based Condiional Forecas...7. Condiional Forecas Based on Hypoheical Shock o Global Growh... Appendix... References...

5 3 I. INTRODUCTION Colombia s economic growh has risen markedly in recen years. Real GDP growh averaged less han 3 percen over 99 3, bu acceleraed o ½ percen in. Growh in he year ending June 7 was close o percen, a pace ha had no been observed in Colombia since he lae 97s. Boh domesic and exernal facors are believed o have played a role in his improved performance. On he domesic side, Colombia has implemened in recen years imporan economic reforms ha have srenghened he policy framework (IMF, ), whereas he securiy siuaion has improved markedly. These facors have helped enhance he domesic business environmen, and conribued o he sharp increase in privae invesmen ha has underpinned he recen growh surge. On he exernal side, Colombia has benefied from very favorable condiions, characerized by srong global growh, improving erms of rade, abundan inernaional liquidiy, and low ineres raes. An imporan quesion is o wha exen economic growh has been driven by exernal facors vis-à-vis domesic ones, and how sensiive growh is o changes in exernal condiions. This paper uses a Bayesian VAR (BVAR) model o address hese issues. The model is esimaed using a recenly developed mehodology by Villani () which allows for he specificaion of informaive seady-sae priors for he variables used. A BVAR model wih informaive seadysae priors subsanially reduces he problem of degrees of freedom arising from he generous parameerizaion ha ends o characerize convenional VAR models. The approach has been found, iner alia, o improve forecasing performance compared o oher empirical models. This paper builds on he effors of Öserholm and Zeelmeyer () in quanifying he role of exernal facors in Lain American growh. We exend heir framework by explicily incorporaing domesic facors ha are hough o have played a key role in Colombia s growh experience. The focus is on variables ha reflec economic policy decisions, such as fiscal and moneary policy variables. Wih his in mind, he model also aemps o capure changes in Colombia s invesmen climae, which may be relaed, iner alia, o changes in he domesic policy environmen. Impulse response funcions and variance decomposiion analysis are underaken o show how domesic and exernal facors affec growh. The paper also examines how much of he recen growh surge owes o exernal facors by performing a hisorical decomposiion using he mehod of Adolfson e al. (7). In addiion, we compare he ou-ofsample forecasing performance of he BVAR model o ha of alernaive models. Finally, in a forward-looking exercise, an assessmen is underaken of he growh implicaions of (i) expeced changes in exernal condiions in and (ii) a less-benign exernal environmen han presenly expeced. The res of his paper is organized as follows. Secion briefly presens he basic srucure of he model, and Secion 3 describes is empirical implemenaion. Secion discusses he esimaion Privae invesmen rose from 9 percen of GDP in o 9 percen of GDP in.

6 resuls, including impulse response funcions, variance decomposiions, hisorical decomposiions, ou-of-sample forecasing assessmens and resuls from he condiional forecasing exercise. Finally, Secion concludes. II. THE MODEL In his paper we will rely on a VAR model for our analysis of Colombian GDP growh. VAR models have several advanages; for example, hey impose very few resricions on he dynamics of he sysem and are considered o perform reasonably well in forecasing. However, he generous parameerizaion of mos VAR models can in paricular in combinaion wih small samples lead o a deerioraion in forecasing performance. Employing parsimonious model specificaions is one way o address his issue. However, ha also means ha inerpreabiliy is sacrificed o a greaer or lesser exen, as he number of quesions ha can be addressed becomes limied. An alernaive approach is o rely on Bayesian VAR modelling, which reduces he degrees-of-freedom problem by inroducing relevan prior informaion. In general, his leads o a subsanial improvemen in forecasing performance over classical VARs. We will herefore employ a Bayesian VAR for our analysis. The model we employ is a paricular specificaion of a Bayesian VAR model, recenly developed by Villani (). The mehodology akes is saring poin in he observaion ha he forecaser ofen has poenially valuable informaion regarding he seady-sae values of some variables. Villani suggess an innovaive soluion o bringing ha informaion o bear in he esimaion by allowing for an informaive prior o be placed on he seady sae of he process. The idea is ha his informaion will make forecass converge o a level ha he forecaser judges reasonable. If he forecaser is correc, his should improve he forecasing performance of he model, paricularly a longer horizons, and some research shows ha his ends o be he case; see, for example, Adolfson e al. (7), Öserholm () and Öserholm and Zeelmeyer (). The model is given by ( L)( x ψ) η G = () where G p ( L ) = I G L G L p is a lag polynomial of order p, x is an nx vecor of saionary macroeconomic variables and η is an nx vecor of iid error erms fulfilling E ( η ) = and E ( η η ) = Σ. This model has he feaure ha ψ provides he seady sae. I is ypically he case ha he forecaser has a reasonably accurae view of he parameers of ψ and an informaive prior disribuion can accordingly be specified. Priors on he parameers of he model are as follows: The prior on Σ is given by p ( n+) ( Σ ) Σ, he prior on ( G) G = G G p vec where ( ) is given by

7 vec ( G) ~ ( θ, ) N and, finally, he prior on ψ is given by ψ ~ N ( θ, ) pn G Ω G n ψ Ω ψ. This choice of priors implies ha he prior on Σ is non-informaive; he priors on he vecors of dynamic vec G and he seady sae parameers ψ will, on he oher hand, generally be coefficiens ( ) informaive. The priors on ψ are discussed in more deail below. III. EMPIRICAL IMPLEMENTATION Variables capuring boh domesic and exernal deerminans of growh were included in he model. The wo blocks consiss of four variables each; denoing he vecor of variables by x, we se ( Δ Δ Δ ) world US y i EMBI HY FDI g y i x, () = world where y, he logarihm of world real GDP (excluding Colombia); i US, he nominal hree-monh U.S. reasury bill rae; EMBI, he JP Morgan emerging marke bond index spread for Lain America (excluding Colombia); and HY, he high-yield corporae bond spread in he Unied Saes (aiming o capure general invesor risk aversion), consiue he exernal block. The domesic block is made up of FDI, foreign direc invesmen as a share of GDP (assumed o have an effec on Colombian GDP in iself bu also hough o proxy he invesmen climae in Colombia); g, he logarihm of real governmen spending; y, he logarihm of Colombia s real GDP; and i, he nominal bank lending rae in Colombia. The daa are shown in Figure. Seady-sae priors are based on a combinaion of heory, empirical esimaes used in he lieraure and he daa iself. The priors used for each variable are shown in Table. The prior for world GDP growh was based on medium-erm projecions from he Fall 7 World Economic Oulook (WEO). The choice of prior for he U.S. hree-monh reasury bill rae is based on combining an inflaion arge of around wo percen wih he Fisher hypohesis, where he equilibrium real ineres rae is also assumed o be approximaely wo percen. These values are in line wih values suggesed by Taylor (993) and Clarida e al. (99). For he EMBI and highyield bond spread, we adoped he priors of Öserholm and Zeelmeyer (). For he seady sae prior for FDI, neiher heory nor he lieraure provide srong guidance; in his ligh, a relaively wide disribuion which largely seems in line wih he daa was accordingly specified. For Colombian governmen spending and GDP growh, he priors were based no only For he priors governing he dynamics of he model, we employ a modified version of he Minnesoa prior (Lierman, 9). The prior mean on he firs own lag is se o.9 if a variable is modelled in levels and if i is in growh raes; all oher coefficiens in G have a prior mean of zero. The reason for he modificaion of he radiional Minnesoa prior is ha a prior mean on he firs own lag equal o is heoreically inconsisen wih he meanadjused model, since a random walk does no have a well-specified uncondiional mean.

8 Figure. Daa. World GDP growh 7 US 3m bill rae EMBI High yield FDI Governmen spending growh Colombia GDP growh Lending rae

9 7 Table. 9 Percen Prior Inervals For Parameers Deermining Seady-Sae Values 9 percen prior probabiliy inerval world Δy US i EMBI HY FDI Δg Δy i (3.7,.7) (3.,.) (.,.) (3.,.) (3.,.) (.,.) (.,.) (.,.) on hisorical performance, bu on economeric sudies of he impac of economic reforms on long-run GDP growh in Lain America; see, for example, Loayza e al. () or he survey by Zeelmeyer (). Finally, he prior on he lending rae is reasonably wide, which reflecs he wide degree of uncerainy regarding he nexus beween nominal ineres rae changes and oupu during he sample period. 3 Seing lag lengh o p =, we esimae he model using quarerly daa from 99Q o 7Q. IV. RESULTS A. Impulse Responses and Variance Decomposiion The discussion in his secion focuses on resuls for Colombian GDP growh; he full se of impulse response funcions and variance decomposiion resuls are presened in Figures A and A in he Appendix. The generaion of impulse response funcions follows sandard pracice. Impulse responses for Colombian GDP reflec one sandard-deviaion shocks. A sandard Cholesky decomposiion of he variance-covariance marix was used o idenify independen sandard normal shocks ε based on he esimaed reduced form shocks; ha is, he relaionships Σ = PP and ε = P η, wih he variables ordered as in x in equaion (), were used. 3 I can be noed ha he prior for his variable is cenered on a number ha exceeds he sum of he seady sae GDP growh rae and an inflaion arge of, say, 3- percen. However, given ha he variable we use is a lending rae, inermediaion coss and a risk premium need o be added o ha sum in order o arrive a a more relevan seadysae value. A one-sandard deviaion shock is equivalen o.3 percenage poins for global growh, 3 basis poins for he U.S. reasury bill rae, 7 basis poins for he EMBI spread, 3 basis poins for he high yield bond spread,. percenage poins for FDI,.9 percenage poin for public spending growh,.7 percenage poins for Colombian GDP growh and basis poins for he domesic ineres rae.

10 Virually all impulse responses for Colombian growh show he expeced sign over relevan ime horizons (Figure ). Excepions are he responses on impac o global growh and FDI, which, however, urn posiive afer he firs quarer. For mos shocks, he response of Colombian growh is also significan a shor horizons, excep for he shocks o he U.S. reasury bill rae and EMBI spread which boh are fairly imprecisely measured. Colombian growh is fairly sensiive o global growh. The impulse response funcion implies ha if global growh has fallen by one percenage poin four quarers afer he shock, Colombian GDP growh has a he same ime fallen roughly by. percenage poins. Noe ha in he model he impac of global growh is ransmied boh hrough he radiional rade channel and via changes in exernal financial condiions. As can be seen in Figure A in he Appendix, shocks o global growh also generae subsanial changes in he EMBI and high-yield bond spreads, which in urn have an effec on Colombian growh. While more moderae han he effec of global growh, he impac of shocks o exernal financial condiions is generally subsanial. An increase of basis poins in he EMBI spread would lower Colombian GDP growh by roughly.3 percenage poins afer he firs year. For he high yield spread, a basis poin shock would cause Colombian GDP growh o fall by approximaely. percenage poins. The effec is subsanially larger a shorer horizons, hough. In conras, a shock o he U.S. ineres rae has a small impac on Colombian growh. Noe also ha he response of he domesic lending rae o shocks o he U.S. rae is saisically insignifican, suggesing ha moneary policy in Colombia is independen of U.S. moneary policy. Growh is moderaely sensiive o changes in domesic variables. A one percenage poin increase in he raio of FDI o GDP (a proxy for he invesmen climae) would raise Colombian GDP growh by roughly. percenage poin afer one year. Fiscal policy also affecs markedly GDP growh in a Keynesian fashion, ha is, expansionary fiscal policy has a posiive effec on growh in he shor-run he esimaed impulse response implies ha a one percen increase in public spending raises GDP growh by.3 percenage poins. Finally, moneary policy also has a subsanial effec on GDP growh an increase of basis poins in he lending rae reduces GDP growh by close o.3 percenage poin afer one year. The response o global growh shocks is sronger han ha esimaed by Öserholm and Zeelmeyer () for an aggregae of six Lain American counries. These auhors esimaes imply roughly a one-for-one relaionship beween domesic growh and global growh a he same ime horizon. The sronger response of he Colombian economy could reflec is higher degree of rade openness (for mos of he sample period), combined wih a fair degree of sensiiviy o changes in exernal financial condiions. I should be noed, however, ha he wo models are no fully comparable, as he se of variables hey include is no he same; Öserholm and Zeelmeyer do no include domesic variables in heir model, while including a commodiy-price variable.

11 9 Figure. Impulse Response Funcions for Colombia GDP Growh % confidence bands 9% confidence bands. World GDP Grow h. U.S. 3-monh Treasury Bill EM BI. High-yield Bond FDI. Governmen Spending Colombia GDP Grow h. Lending Rae

12 Turning o he variance decomposiion in Figure 3, i can inially be noed ha he model explains a very large share of he forecas error variance of Colombian GDP growh. The variance explained by own shocks is only a ouch more han percen (a he quarer horizon), which is a fairly low proporion for a VAR. The variance decomposiion also reveals ha boh foreign and domesic facors are imporan o economic growh in Colombia, wih he conribuion from he laer being higher. I should be noed, however, ha breaking down he conribuion o growh ino domesic and foreign facors is no sraighforward. I is possible ha some variables noably he invesmen climae variable and governmen spending reflec also he influence of foreign facors, which would naurally oversae he role of domesic facors. The model resuls sugges ha exernal facors accoun for abou percen, and domesic facors percen. World GDP growh, governmen spending and FDI are apar from own shocks he mos imporan facors, explaining abou 7,, and percen, respecively, a he -quarer horizon. Oher exernal facors play a more modes role, wih he U.S. ineres rae, he EMBI spread, and he high yield bond spread each accouning for around percen. The conribuion from domesic moneary policy is even smaller, wih he lending rae explaining only hree percen of Colombian growh. B. Hisorical Decomposiion To invesigae o wha exen exernal facors have conribued o he recen surge in economic growh, a hisorical growh decomposiion is conduced for he 7 period. The approach by Adolfson e al. (7) is followed o perform his exercise. Based on his approach, acual growh oucomes and he endogenous forecass are iniially compared for he period seleced. As can be seen from Figure, his comparison indicaes ha acual growh was generally sronger han prediced by he model over o. The implicaion is ha some combinaion of favorable shocks hi he economy during ha period. The esimaes of he role of foreign facors in his period are derived from he model s forecas of Colombian GDP growh if only foreign shocks would have hi he economy afer Q. A similar exercise is also performed o esimae he role of moneary and fiscal policy shocks, and of changes in he invesmen climae. Noe ha he various shocks have been idenified by he model ex pos. For example, changes in he erms of rade could affec such variables. However, a version of he model including he erms of rade produced virually he same resuls as our preferred specificaion. In paricular, he domesic growh response o erms-of-rade shocks was no saisically differen from zero, while he variance decomposiion assigned a very minor role o ha variable as a conribuor o growh. Since FDI in he mineral secors (oil and mining) could also respond o changes in he erms of rade, a model specificaion wih he invesmen climae variable including only non-mineral FDI was also run. This, however, generaed only very minor changes in he resuls.

13 Figure 3. Variance Decomposiion for Colombia GDP Growh. World GDP Grow h. U.S. 3-monh Treasury Bill EM BI. High-yield Bond FDI. Governmen Spending Colombia GDP Grow h. Lending Rae

14 Figure. Foreign and Domesic Facors in -7 Growh Acual Endogenous Foreign facors. Acual Endogenous FDI Q Q 3Q3 Q Q 7Q. Q Q 3Q3 Q Q 7Q 9.. Acual Endogenous Public spending and lending rae 9.. Acual Endogenous Colombian GDP grow h Q Q 3Q3 Q Q 7Q. Q Q 3Q3 Q Q 7Q

15 3 As can be seen from he op lef panel, he model suggess ha he foreign shocks were no paricularly favorable in and. No unil lae were he foreign shocks posiive for Colombian GDP growh. This migh seem somewha surprising, as mos economiss would agree ha exernal condiions were favorable in. However, i should be kep in mind ha he model s endogenous forecas of he exernal environmen was also quie opimisic. Turning o he effec of FDI shocks shown in he op righ panel he model indicaes ha changes in he invesmen climae have been consisenly posiive during his period, providing a simulus o he Colombian economy. This is consisen wih he improvemen in he domesic securiy siuaion and in economic policies ha ook place in Colombia during his period. The fiscal and moneary policy shocks are found o have largely he opposie paern of he foreign shocks, as can be seen in he lower lef panel. They were posiive a he beginning of he period under consideraion bu appear o have been less favorable from early. Finally, for compleeness, he las char of Figure shows he effec of only adding he shocks o Colombian GDP growh. This largely shows he opposie paern o he macroeconomic policy shocks. C. Ou-of-Sample Forecasing: A Comparison The ou-of-sample forecasing performance of he BVAR model wih informaive priors is compared o ha of a convenional BVAR and o a naïve forecas. The convenional BVAR is given by ( L) x Φ η G = + (3) where G ( L), x and η all are defined as in equaions () and (). Comparing he model in equaion (3) o ha in equaion (), i should be noed ha i ypically is difficul o specify a prior disribuion for Φ as i does no have an economically inuiive inerpreaion. The soluion o his problem is generally o employ a non-informaive prior for Φ and we will follow his convenion; he priors for Σ and G ( L) are unchanged relaive o he ones for he mean-adjused BVAR. The ou-of-sample forecas exercise follows sandard pracice: The wo BVAR models are iniially esimaed using daa from 99Q o Q and used o generae forecass o Q, ha is, eigh quarers ahead. 7 The forecass from he wo BVAR models and he naïve forecas are hen compared o he acual values and errors are recorded. We hen exend ha sample one period, re-esimae he models and generae new forecass eigh periods ahead and so on. The las 7 In he exercise using he wo BVAR models, for every draw from he poserior disribuion of parameers a sequence of shocks is drawn and used o generae fuure daa. This leads o as many pahs for each variable as we have ieraions in he Gibbs sampling algorihm. For each of he wo models, a cenral forecas is hen generaed as he median forecas based on he forecas densiy a each horizon. These cenral forecass are used for he poin forecas comparison.

16 evaluaion is conduced on a model esimaed from 99Q o 7Q and only forecased one period ahead. The roo mean square error (RMSE) is used o compare he forecasing performance of he models. A relaive RSME smaller han one means ha he mean-adjused BVAR forecass beer han he alernaive model a a given forecasing horizon. As can be seen if Figure, he meanadjused model almos always ouperforms he oher models. Only for he lending rae is he mean-adjused model consisenly ouperformed by a naïve forecas. This is no compleely surprising, hough i is well-known ha i is very hard o bea a naïve forecass for nominal ineres raes since hey are exremely persisen and are frequenly modeled as uni-roo processes (see, for example, Campbell and Shiller, 99). Moreover, looking a he lending rae over he sample for which he ou-of-sample exercise was conduced, i can be noed ha i was virually fla. This largely explains he exremely good resuls for he naïve forecas. D. Uncondiional and Condiional Forecass Having esablished ha he forecasing performance of he mean-adjused BVAR model is good, we nex generae uncondiional (endogenous) and condiional forecass of Colombian growh hrough. The uncondiional forecas is fully model-based, while he condiional forecas is derived from imposing pahs on seleced variables. We carry ou wo condiional forecass. The firs imposes pahs on hose variables for which sandard projecions are available, namely, world growh (from he IMF s Fall 7 World Economic Oulook [WEO]) and he U.S. ineres rae (from he IMF s Wesern Hemisphere Deparmen bu consisen wih WEO projecions). The second condiional forecas is based on a hypoheical, alhough arguably plausible, scenario where global growh is lower han projeced in he Fall 7 WEO. The endogenous and WEO-based condiional forecass shown in Figures and 7 produce somewha differen resuls. Under he fully endogenous forecas, economic growh deceleraes o around ½ percen by end- and sabilizes a abou percen in 9. The WEO-based condiional forecas, on he oher hand, generaes growh of abou ¼ percen in by he end of and ¾ percen in lae 9. These predicions are broadly in line wih projecions in he Fall 7 WEO. The sronger average growh under he condiional forecas is due largely o WEO projecions of world GDP growh being higher han in he endogenous forecass. As seen in he previous secion, global growh has a srong effec on Colombian GDP growh in he model.

17 Figure. Forecasing Performance of Alernaive Models (Relaive Roo Mean Square Errors) Naïve forecas Convenional BVAR. World GDP Grow h. U.S. 3-monh Treasury Bill EM BI. High-yield Bond FDI. Governmen Spending Colombia GDP Grow h. Lending Rae

18 Figure. Uncondiional Forecas / World GDP Growh U.S. 3-monh Treasury Bill 3 3Q Q Q Q3 Q EM BI 3Q Q Q Q3 Q FDI - - 3Q Q Q Q3 Q Colombia GDP Grow h 3Q Q Q Q3 Q 3Q Q Q Q3 Q High-yield Bond 3Q Q Q Q3 Q Governmen Spending - 3Q Q Q Q3 Q Lending Rae 3 3Q Q Q Q3 Q / % confidence bands.

19 7 Figure 7. WEO-Based Condiional Forecas / World GDP Grow h U.S. 3-monh Treasury Bill Q Q Q Q3 Q EM BI 3Q Q Q Q3 Q FDI - - 3Q Q Q Q3 Q Colombia GDP Grow h 3Q Q Q Q3 Q 3Q Q Q Q3 Q High-yield Bond 3Q Q Q Q3 Q Governmen Spending - - 3Q Q Q Q3 Q Lending Rae 3 3Q Q Q Q3 Q / % confidence bands.

20 Figure. Condiional Forecas Based on Hypoheical Shock o Global Growh / World GDP Grow h 7 3 3Q Q Q Q3 Q EM BI 3Q Q Q Q3 Q FDI - - 3Q Q Q Q3 Q Colom bia GDP Grow h 3Q Q Q Q3 Q U.S. 3-monh Treasury Bill 7 3 3Q Q Q Q3 Q High-yield Bond - 3Q Q Q Q3 Q Governmen Spending - - 3Q Q Q Q3 Q Lending Rae 3 3 3Q Q Q Q3 Q / % confidence bands.

21 9 The downside condiional forecas produces a subsanial deceleraion of growh in Colombia, alhough growh remains posiive in all periods. This forecas assumes ha global growh in each quarer of is lower by percenage poin on an annualized basis relaive o he Fall 7 WEO and ha he U.S. hree-monh reasury bill rae decrease in response o his slowdown. As can be seen in Figure, his produces a subsanial decrease in Colombian GDP growh, which reaches a low of 3 percen in lae Q3 (compared o ¾ percen growh under he WEObased condiional forecas). Noe ha under his scenario he EMBI spread which has no been condiioned upon increases a fair amoun. This oucome is highly plausible in ligh of he srong hisorical correlaion beween U.S. downurns and global risk appeie. Afer he sharp decline in Colombian GDP growh, hough, he recovery is prediced o be fairly rapid, wih growh reaching he same level as in he WEO-based forecas by he end of 9. Summing up, he model suppors he view ha Colombian growh is fairly sensiive o changes in global growh. Under he scenario of a less auspicious global environmen, growh would decline o 3 percen, ¾ percenage poins below he baseline forecas. This suggess ha Colombia responds more sharply han oher Lain American counries o global downurns. A he same ime, he exen of he downurn under he less favorable global scenario described here would fall well shor of a full-blown recession, and would be a mild decline in growh by hisorical sandards. V. CONCLUSIONS This paper has invesigaed he imporance of shocks o a number of macroeconomic variables for Colombian GDP growh. A variance decomposiion from he BVAR model indicaes ha domesic facors accoun for abou percen of growh, wih he remainder explained by exernal developmens. Among he domesic facors, he invesmen climae and fiscal policy play a prominen role, while he conribuion from moneary policy has been small. Global economic growh is by far he mos imporan exernal facor behind Colombian growh. Exernal financial condiions, as measured by he U.S. ineres rae and he EMBI and high-yield bond spreads, accoun each only for a modes share of he variaion in domesic growh. The impulse response funcions indicae ha moneary and fiscal policy shocks each have a moderae impac on domesic growh, while he effec of global growh is considerably sronger. Changes in he invesmen climae also affec growh in a moderae fashion. The model s condiional and uncondiional growh forecass are broadly in line wih oher forecass, such as hose from he IMF s WEO, and imply a deceleraion of economic growh o - percen in -, from close o 7 percen in -7 levels. Also, he model shows ha a moderae deceleraion in global growh would lead o a significan slowdown of domesic growh, followed by a relaively rapid recovery. However, domesic growh would remain posiive and would fall well shor of a recession, suggesing domesic resilience o a global downurn. Beyond he resuls of he model, a number of oher consideraions may affec he nexus beween Colombian growh and he exernal environmen. As indicaed above, i is very difficul o

22 compleely separae he roles of domesic and foreign facors, and i is possible ha facors classified as domesic in he model include some effecs of exernal developmens. On he oher hand, he influence of exernal facors could be oversaed, because he variance decomposiion and impulse response funcions are esimaed on he basis of daa including he 99s. Thus, hey may no fully capure he effecs of he srucural reforms implemened since he early s in Colombia. These reforms which have significanly srenghened he economic policy framework and likely enhanced he economy s flexibiliy may have made Colombia less sensiive o foreign developmens. Moreover, here are oher facors ha would help cushion he effecs of a negaive exernal shock (for example, he high level of inernaional reserves, a flexible exchange rae regime) ha he model may no capure appropriaely. A he same ime, however, greaer inegraion ino he world economy in recen years, noably from a financial sandpoin, may have made he Colombian economy more sensiive o exernal developmens. In his conex, and given he highly favorable exernal condiions of he las few years, he presumpion ha he resilience of he Colombian economy o exernal shocks may have been enhanced in recen years, while enirely plausible, remains o be esed.

23 Appendix Table A. RMSE for Mean-Adjused BVAR world Δ y FDI US i EMBI HY Δ g Δ y i Noe: RMSEs for variables in firs differences are given for four-quarer ended values. Table A. RMSE for Tradiional BVAR world Δ y FDI US i EMBI HY Δ g Δ y i Noe: RMSEs for variables in firs differences are given for four-quarer ended values. Table A3. RMSE for Naïve Forecas world Δ y FDI US i EMBI HY Δ g Δ y i Noe: RMSEs for variables in firs differences are given for four-quarer ended values.

24 Figure A. Impulse Response Funcions % confidence bands 9% confidence bands US 3m bill rae World GDP growh EMBI World GDP growh s US 3m bill rae s EMBI s. -. High yield s x - FDI s x -3 x -3 Gov. spending x - growh s x x -3 - x -3 - Colombia GDP growh s - - x -3 x -3 Lending x -3 rae s - x -3 - x -3 - High yield x -3 - x -3 - x x -3 Colom bia G DP growh FDI Lending rae Gov. spending growh

25 3 Figure A. Variance Decomposiion US 3m bill rae W orld GDP growh World GDP growh s US 3m bill rae s..... EMBI s.. High yield s.. FDI s. Colombia GDP growh s Gov. spending growh s Lending rae s EMBI High yield FDI Colombia GDP growh Lending rae Gov. spending growh.... Horizon.... Horizon.... Horizon.... Horizon.... Horizon.... Horizon.... Horizon.... Horizon

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