Structural scenario analysis with SVARs

Abstract

Macroeconomists seeking to construct conditional forecasts often face a choice between taking a stand on the details of a fully-specified structural model or relying on empirical correlations from vector autoregressions and remain silent about the underlying causal mechanisms. This paper develops tools for constructing "structural scenarios" that can be given an economic interpretation using identified structural VARs. We provide a unified and transparent treatment of conditional forecasting and structural scenario analysis and relate our approach to entropic forecast tilting. We advocate for a careful treatment of uncertainty, making the methods suitable for density forecasting and risk assessment. We also propose a metric to assess and compare the plausibility of alternative scenarios. We illustrate our methods with two applications: assessing the power of forward guidance about future interest rate policies and stress testing the reaction of bank profitability to an economic recession.

Shock-Dependent Exchange Rate Pass-Through: Evidence Based on a Narrative Sign Approach

“…However, can the improved shock identification be useful in practical policy-making? This section attempts to study the policy implications of our exercise by implementing a structural scenario analysis of the sort proposed by Antolin-Diaz et al (2018). The structural scenario analysis is essentially a forecasting exercise conditional on structural shocks, which highlights the necessity of correctly identifying the exchange rate shock.…”

“…Similarly, the median long-run ERPT ratios to both import prices and consumer prices are also lower than their counterparts in the model without the narrative sign restrictions. Third, we evaluate the policy implications of our findings with the novel structural scenario analysis of Antolin-Diaz et al (2018). The structural scenario analysis is essentially a forecasting exercise conditional on structural shocks, which highlights the effectiveness of the narrative sign identification approach in practical policy-making.…”

“…The narrative sign restrictions help distinguish them. Third, our paper makes a novel contribution to the literature by applying the structural scenario analysis of Antolin-Diaz et al (2018) to forecast future prices conditional on certain exchange rate interventions. Previous studies have stressed the idea that policymakers should take into account what drives the exchange rate movements when forecasting the impact of currency movements on future prices (Shambaugh 2008 andForbes et al 2018a).…”

Binary Conditional Forecasts

“…Forecasts of the latent map directly to the probabilistic forecast of the binary event. We construct the conditional forecasts in a Bayesian framework similar to that described in Antolin-Diaz, Petrella, and Rubio-Ramirez (2018) for VARs with strictly observable predictors, but with an added step in which the latent variable is drawn from an appropriately truncated normal distribution.…”

Bayesian VAR Forecasts, Survey Information and Structural Change in the Euro Area

“…Antolín-Díaz et al (2019) show the equivalence of entropic tilting to linear restrictions on the mean and variance of the forecast distribution for the special case of Gaussian densities.3 More recently,Altavilla et al (2017) suggested a test which can help researchers decide on which moments of the multivariate density they should impose external moment conditions.…”