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Trend breaks, long-run restrictions, and the contractionary effects of technology improvements

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John G. Fernald

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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 Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2005-21.

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Date of creation: 2005
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Handle: RePEc:fip:fedfwp:2005-21

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  3. Susanto Basu & John Fernald & Miles Kimball, 2004. "Are technology improvements contractionary?," Working Paper Series WP-04-20, Federal Reserve Bank of Chicago. [Downloadable!]
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  4. Wendy Edelberg & Martin Eichenbaum & Jonas D.M. Fisher, 1999. "Understanding the Effects of a Shock to Government Purchases," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(1), pages 166-206, January. [Downloadable!] (restricted)
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  5. Jeffrey A. Frankel & Francesco Giavazzi, 2002. "International Seminar on Macroeconomics," NBER Books, National Bureau of Economic Research, Inc, number fran02-1.
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  6. Lawrence J. Christiano & Terry J. Fitzgerald, 1999. "The Band pass filter," Working Paper 9906, Federal Reserve Bank of Cleveland. [Downloadable!]
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  16. Jonas D. M. Fisher, 2006. "The Dynamic Effects of Neutral and Investment-Specific Technology Shocks," Journal of Political Economy, University of Chicago Press, vol. 114(3), pages 413-451, June. [Downloadable!] (restricted)
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  24. Ahmed, Shaghil & Ickes, Barry W. & Ping Wang & Byung Sam Yoo, 1993. "International Business Cycles," American Economic Review, American Economic Association, vol. 83(3), pages 335-59, June. [Downloadable!] (restricted)
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  27. Lawrence J. Christiano & Martin Eichenbaum & Robert Vigfusson, 2006. "Assessing Structural VARs," NBER Working Papers 12353, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Peter N. Ireland & Scott Schuh, 2006. "Productivity and U.S. Macroeconomic Performance: Interpreting the Past and Predicting the Future with a Two-Sector Real Business Cycle Model," Boston College Working Papers in Economics 642, Boston College Department of Economics. [Downloadable!]
    Other versions:
  2. Luca Gambetti & Jordi Galí, 2007. "On the sources of the Great Moderation," Proceedings, Federal Reserve Bank of San Francisco, issue Nov. [Downloadable!]
  3. Peter N. Ireland, 2007. "On the Welfare Cost of Inflation and the Recent Behavior of Money Demand," Boston College Working Papers in Economics 662, Boston College Department of Economics. [Downloadable!]
    Other versions:
  4. Jordi Galí & Luca Gambetti, 2006. "On the Sources of the Great Moderation," Economics Working Papers 1041, Department of Economics and Business, Universitat Pompeu Fabra, revised Jun 2007. [Downloadable!]
  5. 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. [Downloadable!]
  6. Patrick J. Kehoe, 2006. "How to Advance Theory with Structural VARs: Use the Sims-Cogley-Nason Approach," NBER Working Papers 12575, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. Galí, Jordi & Gambetti, Luca, 2008. "On the Sources of the Great Moderation," CEPR Discussion Papers 6632, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  8. Richard Dion & Robert Fay, 2008. "Understanding Productivity: A Review of Recent Technical Research," Discussion Papers 08-3, Bank of Canada. [Downloadable!]
  9. Hashmat Khan & John Tsoukalas, 2005. "Technology Shocks and UK Business Cycles," Macroeconomics 0512006, EconWPA. [Downloadable!]
  10. Carlsson, Mikael & Smedsaas, Jon, 2006. "Technology Shocks and the Labor-Input Response: Evidence from Firm-Level Data," Working Paper Series 198, Sveriges Riksbank (Central Bank of Sweden). [Downloadable!]
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