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The Dynamic Effects of Aggregate Demand and Supply Disturbances

  • Olivier Jean Blanchard
  • Danny Quah

We interpret fluctuations in GNP and unemployment as due to two types of disturbances: disturbances that have a permanent effect on output and disturbances that do not. We interpret the first as supply disturbances, the second as demand disturbances. We find that demand disturbances have a hump shaped effect on both output and unemployment; the effect peaks after a year and vanishes after two to five years. Up to a scale factor, the dynamic effect on unemployment of demand disturbances is a mirror image of that on output. The effect of supply disturbances on output increases steadily over time, to reach a peak after two years and a plateau after five years. 'Favorab1e supply disturbances may initially increase unemployment. This is followed by a decline in unemployment, with a slow return over time to its original value. While this dynamic characterization is fairly sharp, the data are not as specific as to the relative contributions of demand and supply disturbances to output fluctuations. We find that the time series of demand-determined output fluctuations has peaks and troughs which coincide with most of the NBER troughs and peaks. But variance decompositions of output at various horizons giving the respective contributions of supply and demand disturbances are not precisely estimated. For instance, at a forecast horizon of four quarters, we find that, under alternative assumptions, the contribution of demand disturbances ranges from 40 to over 95 per cent.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2737.

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Date of creation: Oct 1988
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Publication status: published as The American Economic Review, Vol. 79, No. 4, pp. 655-673, (September 1989)
Handle: RePEc:nbr:nberwo:2737
Note: EFG
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  1. Clark, Peter K., 1989. "Trend reversion in real output and unemployment," Journal of Econometrics, Elsevier, vol. 40(1), pages 15-32, January.
  2. Olivier J. Blanchard & Lawrence H. Summers, 1986. "Hysteresis and the European Unemployment Problem," NBER Working Papers 1950, National Bureau of Economic Research, Inc.
  3. Matthew Shapiro & Mark Watson, 1988. "Sources of Business Cycles Fluctuations," NBER Chapters, in: NBER Macroeconomics Annual 1988, Volume 3, pages 111-156 National Bureau of Economic Research, Inc.
  4. Cochrane, John H, 1988. "How Big Is the Random Walk in GNP?," Journal of Political Economy, University of Chicago Press, vol. 96(5), pages 893-920, October.
  5. Campbell, John Y & Mankiw, N Gregory, 1987. "Are Output Fluctuations Transitory?," The Quarterly Journal of Economics, MIT Press, vol. 102(4), pages 857-80, November.
  6. Perron, P, 1988. "The Great Crash, The Oil Price Shock And The Unit Root Hypothesis," Papers 338, Princeton, Department of Economics - Econometric Research Program.
  7. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
  8. Prescott, Edward C., 1986. "Theory ahead of business-cycle measurement," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 25(1), pages 11-44, January.
  9. John Y. Campbell & N. Gregory Mankiw, 1987. "Permanent and Transitory Components in Macroeconomic Fluctuations," NBER Working Papers 2169, National Bureau of Economic Research, Inc.
  10. Watson, Mark W., 1986. "Univariate detrending methods with stochastic trends," Journal of Monetary Economics, Elsevier, vol. 18(1), pages 49-75, July.
  11. Olivier J. Blanchard & Mark W. Watson, 1984. "Are Business Cycles All Alike?," NBER Working Papers 1392, National Bureau of Economic Research, Inc.
  12. Danny Quah, 1991. "The Relative Importance of Permanent and Transitory Components: Identi- fication and Some Theoretical Bounds," NBER Technical Working Papers 0106, National Bureau of Economic Research, Inc.
  13. Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 191-205, February.
  14. Francis X. Diebold & Glenn D. Rudebusch, 1988. "Long memory and persistence in aggregate output," Finance and Economics Discussion Series 7, Board of Governors of the Federal Reserve System (U.S.).
  15. Robert J. Gordon, 1986. "The American Business Cycle: Continuity and Change," NBER Books, National Bureau of Economic Research, Inc, number gord86-1, 07.
  16. Lawrence J. Christiano, 1988. "Searching For a Break in GNP," NBER Working Papers 2695, National Bureau of Economic Research, Inc.
  17. Clark, Peter K, 1987. "The Cyclical Component of U.S. Economic Activity," The Quarterly Journal of Economics, MIT Press, vol. 102(4), pages 797-814, November.
  18. Nelson, Charles R. & Plosser, Charles I., 1982. "Trends and random walks in macroeconmic time series : Some evidence and implications," Journal of Monetary Economics, Elsevier, vol. 10(2), pages 139-162.
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