Technology Shock and the Business Cycle in the G7 Countries: A Structural Vector Error Correction Model

This paper investigates the importance of technology shock in explaining fluctuations over business cycles and its contractionary effects. Applying the SVEC model on quarterly data of G7 countries and accounting for long cycles in hours worked, there is evidence of a decline in employment as measured by hours worked and investment following a positive technology shock. Hours worked show a persistent decline in France and UK, and this lasts for seven years in Italy, three years in Japan, two years in the USA and Canada; and one year in Germany. However, our findings suggest that technology shocks may play only a limited role in deriving the business cycles in the G7 countries; for they only account for under 30 percent of the business cycle variation in hours and investment, under 35 percent of the business cycle variation in consumption, and under 50 percent of the business cycle variation in output of most of the G7 countries. Our findings do not support the conventional real business cycle interpretation; instead, they are consistent with the predictions of the sticky-price model.