The Effects of External Shocks on Business Cycles in Emerging Asia: A Bayesian VAR Model

In this paper we analyze the effects of external shocks on countries in Emerging Asia. For that purpose, we estimate a Bayesian Vector Auto-Regressive model (BVAR) with an informative prior on the steady state, including variables representing world economic activity, financial conditions, Chinese GDP and an aggregate GDP index of eight East Asian countries. We show that almost half of the forecast error variance of Emerging Asia's real GDP growth can be explained by external factors. We also conduct an estimation of a classical VAR using maximum likelihood estimation and a traditional BVAR. An out-of-sample forecast evaluation shows that the BVAR with an informative prior on the steady-state outperforms both, the classical VAR and the traditional BVAR. Finally, we simulate a double dip scenario for the world economy and a muted growth path of the Chinese economy using conditional forecasts and show that the economic outlook in Emerging Asia highly depends on the growth path of the world economy and remarkably little on business cycle fluctuations in China.