The Diffusion of European Supply and Demand Shocks on Macroeconomic Fundamentals : Evidence from a Multi-Country Framework

This study investigates the impact of European supply and demand shocks on macroeconomic fundamentals using a multi-country approach. Initially, we construct a globe with 19 countries that constitute about 72 percent of world GDP to conduct the multi-country analysis and estimate the global VAR model from 1990Q1 to 2018Q4 to obtain the steady-state values of all variables used in the analysis. Then we estimate the multi-country new Keynesian model; to examine the effects of shocks, we propagate one standard error negative supply and demand shocks on the European region that comprises Belgium, France, Germany, Greece, Italy, Netherlands, and Spain. The negative demand shock simulates the measures taken in order to control the Covid-19 pandemic during the past one and a half years, and the negative supply shock simulates the subsequent supply chain breaks. Empirical results put forward that a negative European supply shock causes inflationary pressure on all countries, and this shock results in a fall in output in the short-run in all countries other than the Asian countries. With regard to the negative demand shock, both output and inflation initially decrease and eventually revert back to their steady state levels in all countries. The results also show that the most profound impact of European supply and demand shocks is on Eastern European countries