Results and Discussion 2

Results and Discussion 2

DOI: 10.4018/978-1-4666-6018-2.ch008


The empirical analysis of this chapter provides insights into the functioning of the economies of three selected countries. Later in the chapter, the dynamic responses of the model to shocks in indicators of financial development are investigated. To obtain credible impulse response analysis, economic theory is used to set the required identifying restrictions instead of using an “unrestricted” vector autoregressive model. The structural form of the model then is summarised in the chapter by the variance decomposition and impulse response functions. The general results from impulse response functions advocate the theory of financial intermediation arguing that the development of the financial market helps to promote economic growth. Furthermore, the results of variance decomposition shows that different measures of financial development influence the variation of growth variables, particularly investment, savings, and productivity growth.
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8.1 Introduction

As mentioned in earlier chapters, the main objective of this study is to examine the impact of financial development on key macroeconomic developments, such as investment, savings and productivity growth in South Korea, Hong Kong and United Kingdom, considering their uneven financial market structures. The main methodological approach is an application of structural vector autoregression model and the analysis of impulse response functions. However since setting up the traditional and structural VAR models require some pre-requisite tests, the entire previous chapter was dedicated to background work to ensure the quality of the data and appropriateness of the variables used in the model. Accordingly in Chapter 6, we addressed important issues of stationarity, cointegration, and complemented it with causality tests and causation issues.

Moreover, as discussed in Chapter 6, in this study we decided to extend a post-Keynesian model developed by Onaran and Stockhammer’ s (2003), which itself was originally inspired by the work of Bhaduri and Marglin (1990). In particular, our extended model is a macroeconomic framework which follows the dynamics of Kaleckian-Post-Keynesian growth principles with the assumption that the economy is open, hence international trade exists. Therefore, we develop a structural VAR model which is informed by the Post-Keynesian theory and follows its assumptions, instructions, and restrictions. As mentioned in chapter 6, VAR models are of the most successful and flexible models for the analysis of multivariate time series. They are, in particular, useful for describing the dynamic behaviour among model variables. Additionally, these models are used for structural inference and policy analysis.

Structural VAR modelling is a powerful tool for empirical validation of theoretical model, and it accommodates contemporaneous interactions, as well as lagged relationships, features which are crucial in the impulse response analysis and variance decompositions. Therefore, in this chapter, the main objective is to set up a structural VAR, which enables us to investigate the general behaviour of the empirical model, and it allows us to compare the findings with the theoretical assumptions of the model.

The empirical analysis of this chapter provides insights into the functioning of the economies of the three selected countries (that are South Korea, Hong Kong and United Kingdom), the empirical steps also allows us to investigate the dynamic responses of the model to shocks (unexpected variations) in indicators of financial development, and to determine whether the effects of such shocks on the key macroeconomic variables (namely investment, saving, income distribution, productivity growth, next export, and unemployment) will disappear overtime.

To obtain credible impulse responses analysis, Sims (1986) and Bernanke (1986) advocated the use of economic theory to set the required identifying restrictions instead of using an ‘unrestricted’ VAR model. The structural form of the model can then be suitably summarised by the impulse response functions and the variance decomposition. Hence, by imposing enough restrictions based on the economic theory (that is Kaleckian-Post-Keynesian theory), the model is ‘exactly’ identified and impulse responses may be given a ‘structural’ interpretation. Short run restrictions (informed by the economic theory) are imposed and reveal contemporaneous feedback effects among the variables. It is important to recall that impulse responses represent the dynamic adjustment towards the steady state. As the steady state corresponds to the deterministic state of the economy, the impulse response function is characterised by the number of periods away from the steady state by which the economy could return to the equilibrium depending on the structure of the economy.

This chapter is structured as follows: Section 2 reports the mechanism of setting up an unrestricted VAR and presents VAR residual tests for every equation in the system separately for each country. Section 3 discusses the identification issues and discusses the results of the structural VAR estimation based on this specification; this section also contains block exogeneity test results. Section 4 discusses the results of impulse response functions derived for each country separately, and provides interpretation of the responses. Section 5 discusses the results of variance decomposition, and Section Six offers a brief conclusion of the chapter.

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