How Trade Composition Affects Sensitivity to Foreign Shocks: Applying a Global VAR Model to Ukraine

Abstract

This paper studies the transmission of foreign output shocks to real activity in Ukraine through international trade. We employ a global vector auto regressive (GVAR) model that captures about 80% of the world economy and incorporates time-varying trade and financial weights. According to our estimates, a mild recession in the US of a 1% drop in output generates a substantial recession in Ukraine of about 2.2%. A similar drop of output in the euro area and Russia translates to a drop in output of about 1.7% in Ukraine. Finally, the same drop of output in CEE, China, or the CIS leads to an output decline of about 0.4% in Ukraine. Meanwhile, Ukraine’s response to euro area output shock has been steadily increasing over the last couple of decades due to changes in global trade flows. Ukraine’s sensitivity to shocks in the US and euro area is notably strengthened by indirect trade effects, while the response to shocks from emerging economies, i.e., China, CEE, the CIS, and partially Russia, is mainly determined by bilateral trade linkages.