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Why Did the Sign of the Price-Output Correlation Change? Evidence from a Structural VAR with GARCH Errors

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Author Info
James Peery Cover () (Department of Economics, Finance & Legal Studies, University of Alabama)
C. James Hueng () (Department of Economics, Western Michigan University)

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Abstract

It is generally agreed that the price-output correlation in the United States was positive prior to the Second World War, but became negative during the postwar period (at least by 1972). This paper offers evidence that the price-output correlation changed signs because of a decrease in the variability of aggregate demand. A structural VAR with bivariate GARCH (1,1) errors is used to estimate a times series of price-output correlations as well as of the conditional variances of the structural shocks to AD and AS. It is found that during the postwar period the price-output correlation is negative and significantly different from zero only when the standard deviation of the AD shock is less than that of the AS shock.

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File URL: http://web.bsu.edu/cob/econ/research/papers/cover_2006.pdf
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File Function: First version, 2006
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Publisher Info
Paper provided by Ball State University, Department of Economics in its series Working Papers with number 200602.

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Length: 27 pages
Date of creation: Mar 2006
Date of revision: Mar 2006
Handle: RePEc:bsu:wpaper:200602

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Related research
Keywords: Price-Output Correlation; Structural VAR; Supply and Demand Shocks; Blanchard-Quah Decomposition;

Find related papers by JEL classification:
E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions

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  1. Cover, James Peery & Enders, Walter & Hueng, C. James, 2006. "Using the Aggregate Demand-Aggregate Supply Model to Identify Structural Demand-Side and Supply-Side Shocks: Results Using a Bivariate VAR," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(3), pages 777-790, April. [Downloadable!] (restricted)
  2. James Peery Cover & Paul Pecorino, 2003. "Optimal Monetary Policy and the Correlation between Prices and Output," The B.E. Journal of Macroeconomics, Berkeley Electronic Press, vol. 0(1). [Downloadable!]
  3. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January. [Downloadable!] (restricted)
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  11. Judd, John P & Trehan, Bharat, 1995. "The Cyclical Behavior of Prices: Interpreting the Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(3), pages 789-97, August. [Downloadable!] (restricted)
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  13. Cooley, Thomas F. & Ohanian, Lee E., 1991. "The cyclical behavior of prices," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 25-60, August. [Downloadable!] (restricted)
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  14. Smith, R Todd, 1992. "The Cyclical Behavior of Prices," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 24(4), pages 413-30, November. [Downloadable!] (restricted)
  15. Hartley, James E, 1999. "Real Myths and a Monetary Fact," Applied Economics, Taylor and Francis Journals, vol. 31(11), pages 1325-29, November. [Downloadable!] (restricted)
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  18. Floden, Martin, 2000. "Endogenous monetary policy and the business cycle," European Economic Review, Elsevier, vol. 44(8), pages 1409-1429, August. [Downloadable!] (restricted)
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