Are neutral and investment-specific technology shocks correlated?

Abstract

The joint behavior of Total Factor Productivity (TFP) and the Relative Price of Investment (RPI) in the data lead several authors to conclude that neutral technology shocks are positively correlated with investment-specific technology shocks, challenging the specification of standard macroeconomic models. This paper rejects the correlated-shocks hypothesis using both parametric and non-parametric methods and controlling for structural breaks. The data suggests moderately negative long-run covariation between the RPI and TFP constructed from chain-linked output, but the RPI is orthogonal to TFP in consumption units. These results are consistent with a simple two-sector model in which neutral technology shocks and investment-specific technology shocks are uncorrelated, while models with correlated shocks cannot account for the second result. I conclude that it is not necessary to adapt macro models to allow for correlated technology processes.