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Interpreting Permanent Shocks to Output When Aggregate Demand May Not be Neutral in the Long Run

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  • John W. Keating

    (Department of Economics, The University of Kansas)

Abstract

This paper studies Blanchard and Quah’s (1989) statistical model of permanent and transitory shocks to output using a set of arguably more plausible structural assumptions. Economists typically motivate this statistical model by assuming aggregate demand shocks have no long-run effect on the level of output. Many economic theories are, however, inconsistent with that assumption. We reinterpret this statistical model assuming a positive shock to aggregate supply lowers the price level and in the long run raises output while a positive shock to aggregate demand raises the price level. No assumption is made about the long-run output effect of aggregate demand. Based on these assumptions, we show that a puzzling finding from the empirical literature implies that a positive (negative) aggregate demand shock had a long-run positive (negative) effect on the level of output in a number of pre-World War I economies.

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Bibliographic Info

Paper provided by University of Kansas, Department of Economics in its series WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS with number 201205.

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Length: 13 pages
Date of creation: Feb 2012
Date of revision:
Handle: RePEc:kan:wpaper:201205

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Related research

Keywords: vector autoregression; identification restrictions; moving average representations; aggregate demand and supply theory; permanent and transitory shock decomposition;

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References

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  1. Lawrence J. Christiano & Martin Eichenbaum & Robert J. Vigfusson, 2005. "Alternative procedures for estimating vector autoregressions identified with long-run restrictions," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 842, Board of Governors of the Federal Reserve System (U.S.).
  2. Waggoner, Daniel F. & Zha, Tao, 2003. "Likelihood preserving normalization in multiple equation models," Journal of Econometrics, Elsevier, Elsevier, vol. 114(2), pages 329-347, June.
  3. Keating, John W & Nye, John V, 1998. "Permanent and Transitory Shocks in Real Output: Estimates from Nineteenth-Century and Postwar Economies," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 30(2), pages 231-51, May.
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Cited by:
  1. Keating, John W., 2013. "What do we learn from Blanchard and Quah decompositions of output if aggregate demand may not be long-run neutral?," Journal of Macroeconomics, Elsevier, Elsevier, vol. 38(PB), pages 203-217.

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