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. Question 1 (10 Marks) Consider the structural VAR model yt = ⇡ + ⇧yt1 + ut (1) ut = B✏t (2) ✏t ⇠ N(0, Ik) (3) Suppose all parameter values are known. Define ei as a vector of dimensions k ⇥ 1 of entries zero, except for entry j which equals 1. A researcher proposes to estimate impulse responses to shock j as follows: 0 = ⇡ + Bei, (4) 1 = ⇡ + 0, (5) 2 = ⇡ + 1, (6) . . . (7) Discuss if you agree or disagree with this approach, and carefully explain your answer. 2. Question 2 (10 Marks) Explain why macroeconomists use the concept of ‘shocks’ for their analysis. In the context of monetary policy, what does a ‘monetary policy shock’ actually mean? -2- See Next Page 7QQMM205 3. Question 3 (10 Marks) Suppose you are working with a SVAR model and you want to identify impulse responses to an uncertainty shock. Suppose your model includes the VXO as a measure of uncertainty. A researcher suggests to construct the following instrument for an uncertainty shock: mt = ↵ · V XOt (8) with ↵ an arbitrary parameter set by the researcher. The rational is that this instrument mt for the uncertainty shock would certaintly be correlated with the measure of uncertainty and will hence be suitable to study uncertainty shocks. Clearly say if you agree or disagree with this approach and explain your answer.