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Prepared by Juliana Araujo and Kristin Magnusson.
Panama has no national currency or central bank and has the U.S. dollar as its only legal tender. This means that neither money supply nor credit are buffered or amplified by domestic monetary policy considerations.
Previous work (Swiston, 2010) has found trade in goods and services to be an important transmission channel of shocks from the United States to Panama, but we chose not to include it given the presence of U.S. GDP growth in the model and the paper’s focus on financial and domestic factors. Panama’s large off-shore financial center is also excluded from the model because the segment is largely de-linked from the rest of the economy.
For the first subperiod the prior on US GDP growth was between 1 and 3 percent and for the latter subperiod was -1 and 2 percent. The prior on Panama’s GDP growth rate was between 2 and 8 percent and 6 and 10 percent, respectively.
For the priors governing the dynamics of the model, we follow Litterman, 1986, in using a modified version of the Minnesota prior. If a variable is modified in levels, the prior mean on its first own lag is set to 0.9; if in growth rates, it is set to 0. The reason for modifying the traditional Minnesota prior in this fashion is that a prior mean on the first own lag equal to 1 is theoretically inconsistent with a mean-adjusted model, since a random walk does not have a well-specified mean.
One standard deviations shocks correspond to the following magnitudes for the included variables: 6.6 percent for PAN credit growth, 1.5 percent for PAN government spending, 4 percent for PAN FDI, 4 percent for PAN GDP, and 2 percent for U.S. growth.