Assessing the importance of global shocks versus country-specific shocks

A common assumption is that global shocks have little influence on current accounts, relative output levels, and real exchange rates. We use a four-variable structural VAR of the Sims–Bernanke type that allows us to obtain a global shock and three country-specific shocks. We find that global shocks explain sizable portions of real rate movements and bilateral current account balances. Our decomposition also allows us to measure the extent to which “third-country effects” are important in explaining bilateral real exchange rates and relative output levels.