An integrated Bayesian-principal component approach to macroeconomic resilience: the case of the Central Europe and Baltic macro-region

Abstract

PurposeIn the fashion of Martin (2012), we develop an innovative application to a standard, well-grounded methodology to investigate resilience in two critical dimensions: recovery and resistance. Our novel approach allows us to investigate the resilience performance to the 2008 financial crisis within countries of this macro-region according to their shock isolation and absorptive capacities.Design/methodology/approachBy individually estimating six open economy DSGE models within the Central Europe and Baltic macro-region, we identify the business-cycle-volatility drivers for each country. Then, we use the outcome of our six estimates to conduct a principal component analysis to determine structural common characteristics required to explain economic resilience in the CEB macro-region.FindingsIn terms of resilience, Central European economies exhibit quite similar paths in terms of recovery, meaning they have similar economic structures. By contrast, Baltic countries behave differently, being outliers in opposite extreme positions. The contrary occurs for resistance: Baltic countries share a similar ranking, whereas Central European economies exhibit substantial differences.Research limitations/implicationsIt is important to acknowledge that a limitation of the analysis is that we explicitly consider each country as a stand-alone open economy which are subject to stochastic disturbances. Precisely, we do not model trade or other interactions across countries within the CEB region and with the rest of the world. Consequently, spillover effects in the aftermath of the shock are not accounted for.Originality/valueWe estimate the relative vulnerability or sensitivity of economies within the macro-region to disturbances and disruptions (resistance) and the speed and extent of recovery from such a disruption or recession (recovery). First, we built two different kinds of measures of resilience by aggregating the estimated parameters through non-centered and centered principal component analysis. Then, we use our model to investigate the relation between financial shock and the economic resilience across the region. The approach can be applied to several case studies, parsimoniously.