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Trend Breaks, Long-Run Restrictions and the Contractionary Effects of Technology Improvements

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  • Fernald, John

Abstract

Structural vector-autoregressions with long-run restrictions are extraordinarily sensitive to low-frequency correlations. This paper explores this sensitivity analytically and via simulations, focusing on the contentious issue of whether hours worked rise or fall when technology improves. Recent literature finds that when hours per person enter the VAR in levels, hours rise; when they enter in differences, hours fall. However, once we allow for (statistically and economically plausible) trend breaks in productivity, the treatment of hours is relatively unimportant: Hours fall sharply on impact following a technology improvement. The issue is the common high-low-high pattern of hours per capita and productivity growth since World-War II. Such low-frequency correlation almost inevitably implies a positive estimated impulse response. The trend breaks control for this correlation. In addition, the specification with breaks can easily 'explain' (or encompass) the positive estimated response when the breaks are omitted; in contrast, the no-breaks specification has more difficulty explaining the negative response when breaks are included. More generally, this example suggests a need for care in applying the long-run-restrictions approach.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5631.

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Date of creation: Apr 2006
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Handle: RePEc:cpr:ceprdp:5631

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Keywords: business cycles; structural change; technology;

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Cited by:
  1. Luca Gambetti & Jordi Gal�, 2009. "On the Sources of the Great Moderation," American Economic Journal: Macroeconomics, American Economic Association, vol. 1(1), pages 26-57, January.
  2. Peter N. Ireland, 2008. "On the Welfare Cost of Inflation and the Recent Behavior of Money Demand," NBER Working Papers 14098, National Bureau of Economic Research, Inc.
  3. Peter N. Ireland & Scott Schuh, 2007. "Productivity and U.S. Macroeconomic Performance: Interpreting the Past and Predicting the Future with a Two-Sector Real Business Cycle Model," NBER Working Papers 13532, National Bureau of Economic Research, Inc.
  4. Patrick J. Kehoe, 2006. "How to advance theory with structural VARs: use the Sims-Cogley-Nason approach," Staff Report 379, Federal Reserve Bank of Minneapolis.
  5. Hashmat Khan & John Tsoukalas, 2005. "Technology Shocks and UK Business Cycles," Macroeconomics 0512006, EconWPA.
  6. Richard Dion & Robert Fay, 2008. "Understanding Productivity: A Review of Recent Technical Research," Discussion Papers 08-3, Bank of Canada.
  7. Mikael Carlsson & Jon Smedsaas, 2007. "Technology Shocks and the Labor-Input Response: Evidence from Firm-Level Data," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(6), pages 1509-1520, 09.
  8. Louis Phaneuf & Nooman Rebei, 2007. "Technology Shocks and Business Cycles: The Role of Processing Stages and Nominal Rigidities," Working Papers 07-7, Bank of Canada.

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