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Sources of Business Cycle Fluctuations

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Abstract

What shocks account for the business cycle frequency and long run movements of output and prices? This paper addresses this question using the identifying assumption that only supply shocks, such as shocks to technology, oil prices, and labor supply affect output in the long run. Real and monetary aggregate demand shocks can affect output, but only in the short run. This assumption sufficiently restricts the reduced form of key macroeconomic variables to allow estimation of the shocks and their effect on output and price at all frequencies. Aggregate demand shocks account for about twenty to thirty percent of output fluctuations at business cycle frequencies. Technological shocks account for about one-quarter of cyclical fluctuations, and about one-third of output's variance at low frequencies. Shocks to oil prices are important in explaining episodes in the 1970's and 1980's. Shocks that permanently affect labor output account for the balance of fluctuations in output, namely, about half of its variance at all frequencies.

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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 870.

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Length: 61 pages
Date of creation: Apr 1988
Date of revision:
Publication status: Published in NBER Macroeconomics Annual (1988), 3: 111-148
Handle: RePEc:cwl:cwldpp:870

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Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

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Keywords: Business cycle; supply shocks; inflation; output; demand shocks;

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  1. Clark, Peter K, 1987. "The Cyclical Component of U.S. Economic Activity," The Quarterly Journal of Economics, MIT Press, vol. 102(4), pages 797-814, November.
  2. Beveridge, Stephen & Nelson, Charles R., 1981. "A new approach to decomposition of economic time series into permanent and transitory components with particular attention to measurement of the `business cycle'," Journal of Monetary Economics, Elsevier, vol. 7(2), pages 151-174.
  3. Quah, Danny, 1992. "The Relative Importance of Permanent and Transitory Components: Identification and Some Theoretical Bounds," Econometrica, Econometric Society, vol. 60(1), pages 107-18, January.
  4. Long, John B, Jr & Plosser, Charles I, 1983. "Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 39-69, February.
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