Policy and Business Cycle Shocks: A Structural Factor Model Representation of the US Economy

Mario Forni,Luca Gambetti

doi:10.3390/jrfm14080371

Abstract

We use a dynamic factor model to provide a semi-structural representation for 101 quarterly US macroeconomic series. We find that (i) the US economy is well described by a number of structural shocks between two and five. Focusing on the four-shock specification, we identify, using sign restrictions, two policy shocks, monetary and fiscal, and two non-policy shocks, demand and supply. We obtain the following results. (ii) Both supply and demand shocks are important sources of fluctuations; supply prevails for GDP, while demand prevails for employment and inflation. (ii) Monetary and fiscal policy shocks have sizable effects on output and prices, with no evidence of crowding-out of private aggregate demand components; both monetary and fiscal authorities implement important systematic countercyclical policies reacting to demand shocks. (iii) Negative demand shocks have a large long-run positive effect on productivity, consistently with the Schumpeterian “cleansing” view of recessions.

Highlights

IntroductionHow many shocks drive the business cycle?
Introduction iationsHow many shocks drive the business cycle? What is the relative importance of supply and demand disturbances? What are the effects of macroeconomic policies? These questions have been and still are at the core of the research in macroeconomic since the answer is key to assessing competing theories of the business cycle and the implied policy recommendations.Since Sims (1980) seminal paper, structural Vector Autoregressive models (SVAR)have been a major tool to address the questions above
This paper studies the sources of business cycle fluctuations and the role of macroeconomic policies using a structural factor model

Summary

Introduction

How many shocks drive the business cycle? What are the effects of macroeconomic policies? These questions have been and still are at the core of the research in macroeconomic since the answer is key to assessing competing theories of the business cycle and the implied policy recommendations. Since Sims (1980) seminal paper, structural Vector Autoregressive models (SVAR). Have been a major tool to address the questions above. Such models replaced large scale econometric models, their main advantage being that they do not require the imposition of “incredible” identifying restrictions. Over the last three decades, the SVAR literature has substantially contributed to improve our knowledge of macroeconomic dynamics, providing evidence often used as a guideline by both policymakers and theorists.

Results

Discussion

Conclusion