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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

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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Suggested Citation

  • John W. Keating, 2013. "Interpreting Permanent Shocks to Output When Aggregate Demand May Not Be Neutral in the Long Run," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(4), pages 747-756, June.
    • Handle: RePEc:mcb:jmoncb:v:45:y:2013:i:4:p:747-756
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    File URL: http://hdl.handle.net/10.1111/
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    Cited by:

    1. Ivan Mendieta-Munoz & Mengheng Li, 2019. "The Multivariate Simultaneous Unobserved Compenents Model and Identification via Heteroskedasticity," Working Paper Series, Department of Economics, University of Utah 2019_06, University of Utah, Department of Economics.
    2. Carlos Madeira & João Madeira & Paulo Santos Monteiro, 2026. "The Origins of Monetary Policy Disagreement: The Role of Supply and Demand Shocks," The Review of Economics and Statistics, MIT Press, vol. 108(2), pages 355-371, March.
    3. Binet, Marie-Estelle & Pentecôte, Jean-Sébastien, 2015. "Macroeconomic idiosyncrasies and European monetary unification: A sceptical long run view," Economic Modelling, Elsevier, vol. 51(C), pages 412-423.
    4. 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, vol. 38(PB), pages 203-217.
    5. Keating, John W. & Valcarcel, Victor J., 2017. "What's so great about the Great Moderation?," Journal of Macroeconomics, Elsevier, vol. 51(C), pages 115-142.
    6. Li, Mengheng & Mendieta-Muñoz, Ivan, 2024. "Dynamic hysteresis effects," Journal of Economic Dynamics and Control, Elsevier, vol. 163(C).

    More about this item

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles

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