Figure 7 Basic VARX: Impulse Response Functions <!-- Start of picture text --> Response to Cholesky One S.D. Innovations ± 2 S.E.<br>Response of GAP_DR_BK to GAP_DR_BK Response of GAP_DR_BK to GAP_HT_BK Response of GAP_DR_BK to DLINFL_DUS_DR Response of GAP_DR_BK to DLINFL_DUS_HT Response of GAP_DR_BK to GAP_US_BK<br>.04 .04 .04 .04 .04<br>.03 .03 .03 .03 .03<br>.02 .02 .02 .02 .02<br>.01 .01 .01 .01 .01<br>.00 .00 .00 .00 .00<br>-.01 -.01 -.01 -.01 -.01<br>-.02 -.02 -.02 -.02 -.02<br>1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10<br>Response of GAP_HT_BK to GAP_DR_BK Response of GAP_HT_BK to GAP_HT_BK Response of GAP_HT_BK to DLINFL_DUS_DR Response of GAP_HT_BK to DLINFL_DUS_HT Response of GAP_HT_BK to GAP_US_BK<br>.04 .04 .04 .04 .04<br>.03 .03 .03 .03 .03<br>.02 .02 .02 .02 .02<br>.01 .01 .01 .01 .01<br>.00 .00 .00 .00 .00<br>-.01 -.01 -.01 -.01 -.01<br>-.02 -.02 -.02 -.02 -.02<br>1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10<br>Response of DLINFL_DUS_DR to GAP_DR_BK Response of DLINFL_DUS_DR to GAP_HT_BK Response of DLINFL_DUS_DR to DLINFL_DUS_DR Response of DLINFL_DUS_DR to DLINFL_DUS_HT Response of DLINFL_DUS_DR to GAP_US_BK<br>.16 .16 .16 .16 .16<br>.12 .12 .12 .12 .12<br>.08 .08 .08 .08 .08<br>.04 .04 .04 .04 .04<br>.00 .00 .00 .00 .00<br>-.04 -.04 -.04 -.04 -.04<br>-.08 -.08 -.08 -.08 -.08<br>1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10<br>Response of DLINFL_DUS_HT to GAP_DR_BK Response of DLINFL_DUS_HT to GAP_HT_BK Response of DLINFL_DUS_HT to DLINFL_DUS_DR Response of DLINFL_DUS_HT to DLINFL_DUS_HT Response of DLINFL_DUS_HT to GAP_US_BK<br>.08 .08 .08 .08 .08<br>.04 .04 .04 .04 .04<br>.00 .00 .00 .00 .00<br>-.04 -.04 -.04 -.04 -.04<br>1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10<br><!-- End of picture text --> Source : Author’s calculations.

Figure 7 shows the response of domestic variables in the two countries to an innovation in all the variables at a horizon of 10 periods and using the ordering described earlier. The solid lines (in blue) in the figures represent the impulse responses themselves, whereas the dotted lines (in red) are the associated 95 percent upper and lower confidence bands.<sup>16</sup> The results suggest that domestic variables do not respond significantly to shocks to the US output gap. In addition, domestic variables in one country do not respond either to shocks to domestic variables in the other countries. Thus, these results appear to corroborate the preliminary analysis, based on unconditional correlations, which suggested limited business cycle synchronization between the two countries. At the same time, however, it is possible that the small number of variables included in the VARX does not allow one to properly capture the transmission process of these shocks. To investigate further this potential misspecification problem, we now turn to a more extended model.

> 16The impulse responses and their associated confidence intervals are computed using Monte Carlo simulations employing 1,000 draws. Eviews 3.1 was used to perform all computations.

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