Systemic Risk, Aggregate Demand, and Commodity Prices: An Application to Colombia

We embed a small open economy model for Colombia into the systemic risk model of GGT (2014). The small open economy model is estimated by Bayesian methods and used for analysis and projections. The model enable us to give a consistent treatment of shocks to systemic risk, country risk, and oil and commodity prices. The treatment is consistent because the shocks affect the global economy, not only exogenous “rest of the world” variables. The priors are found by analyzing impulse response functions, the evolution of latent variables, equation fit, error decompositions, and model forecast performance. Among the findings are that the identified episodes of retrenchment and bouyancy in systemic risk were transmitted to Colombia’s country risk premium and that systemic risk shocks are important drivers of Colombia’s output and unemployment gaps. Finally, aggregate demand-related shocks are not important as drivers of non-core inflation in Colombia, in contrast with the findings for other countries.