Economic and VAR Shocks: What Can Go Wrong?

This paper discusses the problem of invertibility between the economic shocks in a dynamic equilibrium model and the corresponding VAR innovations. We present an algebraic check of invertibility based on the model fundamentals and we find the identification scheme that recovers the economic shocks from the VAR innovations when the model is invertible. We illustrate our results with a model of the Great Depression proposed by Christiano, Motto, and Rostagno (2003). (JEL: E00, E32, C32) (c) 2006 by the European Economic Association.