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Interaction between Supply and Demand Shocks in Production and Employment

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  • F.A.G. den Butter

    ()
    (Vrije Universiteit Amsterdam)

  • S.J. Koopman

    ()
    (London School of Economics)

Abstract

A major aim of recent empirical modelling of the business cycle isto identify the relative importance of aggregate supply and demandshocks. Supply or technology shocks are associated with permanent(structural) effects on economic activity whereas demand shocks arerelated to temporary (cyclical) effects. Most studies in this veinuse multivariate VAR-models or the common trends-cointegrationapproach in order to disentangle supply and demand shocks. As analternative, this paper uses the methodology of unobserved (orstructural) components time series models as set out in Harvey(1989) for identification of technology and demand shocks in atwo equation system of labour produc-tivity and industrial output.The novelty is the introduction of correlation between the twotypes of shocks such that the mutual dependency of these shockscan be estimated explicitly. This is because tech-nology shockswill have cyclical (temporary) effects, and demand shocks willhave structural (permanent) effects, which are not fully describedby the interaction of the endogenous variables in the model. Theestimation procedure is set out in Koopman et al. (1995). The datais quarterly time series of labour productivity and industrialoutput for Germany, The Netherlands, the United Kingdom and theUnited States. Our results show that the covariance of the dynamicsof supply and demand shocks appears to be important in thesecountries. It indicates a good coordination is needed betweenstructural and cyclical policies.

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Bibliographic Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 97-052/3.

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Date of creation: 30 May 1997
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Handle: RePEc:dgr:uvatin:19970052

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  1. Finn E. Kydland & Edward C. Prescott, 1996. "The Computational Experiment: An Econometric Tool," Journal of Economic Perspectives, American Economic Association, vol. 10(1), pages 69-85, Winter.
  2. Burnside, Craig & Eichenbaum, Martin & Rebelo, Sergio, 1993. "Labor Hoarding and the Business Cycle," Journal of Political Economy, University of Chicago Press, vol. 101(2), pages 245-73, April.
  3. Jordi Gali, 1996. "Technology, Employment, and the Business Cycle: Do Technology Shocks Explain Aggregate Fluctuations," NBER Working Papers 5721, National Bureau of Economic Research, Inc.
  4. Lawrence J. Christiano & Martin Eichenbaum, 1990. "Current real business cycle theories and aggregate labor market fluctuations," Working Paper Series, Macroeconomic Issues 90, Federal Reserve Bank of Chicago.
  5. Robert G. King & Charles I. Plosser & James H. Stock & Mark W. Watson, 1987. "Stochastic Trends and Economic Fluctuations," NBER Working Papers 2229, National Bureau of Economic Research, Inc.
  6. Jean-Pierre DANTHINE & John B. DONALDSON, 1991. "Methodological and Empirical Issues in Real Business Cycle Theory," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 9102, Université de Lausanne, Faculté des HEC, DEEP.
  7. Olivier Jean Blanchard & Danny Quah, 1988. "The Dynamic Effects of Aggregate Demand and Supply Disturbance," Working papers 497, Massachusetts Institute of Technology (MIT), Department of Economics.
  8. Mellander, Erik & Vredin, A & Warne, A, 1992. "Stochastic Trends and Economic Fluctuations in a Small Open Economy," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(4), pages 369-94, Oct.-Dec..
  9. Dale T. Mortensen & Christopher A. Pissarides, 1993. "Job Creation and Job Destruction in the Theory of Unemployment," CEP Discussion Papers dp0110, Centre for Economic Performance, LSE.
  10. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  11. Ingram, B.F. & Kocherlakota, N.R. & Savin, N.E., 1992. "Explaining Business Cycles : A Multiple Shock Approach," Working Papers 92-09, University of Iowa, Department of Economics.
  12. Steven J. Davis & John C. Haltiwanger & Scott Schuh, 1998. "Job Creation and Destruction," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262540932, December.
  13. Butter, F.A.G. den & Wollmer, F.J., 1992. "An empirical model for endogenous technology in the Netherlands," Serie Research Memoranda 0037, VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics.
  14. Bergman, Michael, 1996. "International evidence on the sources of macroeconomic fluctuations," European Economic Review, Elsevier, vol. 40(6), pages 1237-1258, June.
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