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The determinants of UK business cycles

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  • Allison Holland
  • Andrew Scott

Abstract

This paper considers the ultimate causes of post-war UK business cycles. Using an extended stochastic growth model the authors construct estimates of productivity and preference shocks both of which are highly persistent, volatile and potentially capable of explaining UK business cycles. They find the productivity term is the dominant explanation of UK output fluctuations but that changes in underlying preferences are crucial in understanding employment movements. Holland and Scott use a variety of Granger causality tests to establish whether these productivity and preference terms are predictable and so can be potentially considered as the cause of UK business cycles or whether they are themselves Granger caused by other variables. They find that their estimated productivity term is not predicted by any demand-side variable including various fiscal and monetary policy instruments, but is to a limited extent by oil prices and the share of taxes in GDP. This suggests that their "productivity" shock may also reflect other supply- side influences. In contrast they find their "preference" shift is predicted to a substantial extent by real variables, such as the terms of trade and oil prices, and nominal variables, such as the money supply and the price level. The implications of these findings for competing theories of the business cycles and for the monetary transmission mechanism are discussed.

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Paper provided by Bank of England in its series Bank of England working papers with number 58.

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Date of creation: Jan 1997
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Handle: RePEc:boe:boeewp:58

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