Interpreting Permanent Shocks to Output When Aggregate Demand May Not be Neutral in the Long Run
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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| Length: | 13 pages |
| Date of creation: | Feb 2012 |
| Date of revision: | |
| Handle: | RePEc:kan:wpaper:201205 |
| Contact details of provider: | Postal: Phone: (785) 864-3501 Fax: (785) 864-5270 Web page: http://www2.ku.edu/~kuwpaper/Email: More information through EDIRC
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References listed on IDEAS
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- Waggoner, Daniel F. & Zha, Tao, 2003.
"Likelihood preserving normalization in multiple equation models,"
Journal of Econometrics,
Elsevier, vol. 114(2), pages 329-347, June.
- Daniel F. Waggoner & Tao Zha, 2000. "Likelihood-preserving normalization in multiple equation models," Working Paper 2000-8, Federal Reserve Bank of Atlanta.
- Lawrence J. Christiano & Martin Eichenbaum & Robert J. Vigfusson, 2005.
"Alternative procedures for estimating vector autoregressions identified with long-run restrictions,"
International Finance Discussion Papers
842, Board of Governors of the Federal Reserve System (U.S.).
- Lawrence J. Christiano & Martin Eichenbaum & Robert Vigfusson, 2006. "Alternative Procedures for Estimating Vector Autoregressions Identified with Long-Run Restrictions," Journal of the European Economic Association, MIT Press, vol. 4(2-3), pages 475-483, 04-05.
- 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, vol. 30(2), pages 231-51, May.
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