Exchange rate as a shock absorber in Poland and Slovakia: Evidence from Bayesian SVAR models with common serial correlation

The paper examines whether exchange rates in Poland and Slovakia acted as shock absorbers or shock-propagating mechanisms. A set of Bayesian structural VAR models is built for each country that enables us to identify supply, demand, monetary and financial shocks. Identifying restrictions are derived from the extended stochastic macroeconomic model of an open economy. Sample covers quarterly data 1998-2013. Three main conclusions are as follows. First, it is demonstrated that overly parsimonious VAR models result in an imperfect identification of shocks that distorts the results. Second, empirical evidence is found that the higher exchange rate flexibility in Poland than in Slovakia contributed to the absorption of real shocks. Third, though financial shocks were important source of exchange rate changes in Poland, especially in the run-up to the crisis, their impact on output remained similar to that in Slovakia.