Technology, demand, and productivity: What an industry model tells us about business cycles

Zuzana Molnárová,Michael Reiter

doi:10.1016/j.jedc.2021.104272

Abstract

In this paper, we study the relative importance of demand and technology shocks in generating business cycle fluctuations, both at the aggregate level and at the level of individual industries. We construct a New Keynesian DSGE model that is highly disaggregated at the industry level with an input-output network structure. Measured productivity in the model fluctuates in response to both technology and demand shocks due to endogenous factor utilization. We estimate the model by the simulated method of moments using U.S. industry data from 1960 to 2005.We find that the aggregate technology shock has zero variance. Exogenous shocks to technology are necessary for our model to fit the data, but these shocks are exclusively industry-specific, uncorrelated across industries. The bulk of the aggregate fluctuations, including those in aggregate measured productivity, are explained through shocks to aggregate demand. This shock structure is supported by a host of information from the disaggregate data.Our second finding is that about half of the decrease in the cyclicality of measured productivity in the U.S. after the mid-1980s can be explained by the reduction in the importance of demand shocks, in line with the narrative of the great moderation.

Highlights

What type of shocks are driving business cycles? Contemporary workhorse DSGE models often feature a wide variety of shocks, the importance of which might vary over time
In this paper we focus on a mechanism that is able to generate a decrease in the procyclicality of measured productivity without generating counterfactual predictions at the industry level, which is the change in the structure of shocks, see Barnichon (2010), Foerster et al (2011), Galı and Gambetti (2009)
Endogenous effort explains most of the aggregate fluctuations in measured productivity, and thereby “crowds out” the aggregate technology shocks from our model

Summary

Introduction

What type of shocks are driving business cycles? Contemporary workhorse DSGE models often feature a wide variety of shocks, the importance of which might vary over time. What type of shocks are driving business cycles? For many of the commonly used types of these shocks, there are prevailing controversies about whether they can be interpreted as structural sources of the fluctuations, see for example Chari et al (2009). Many models in the theoretical literature are still built on the assumption that business cycles are driven solely by technology shocks. The plausibility of aggregate technology shocks, i.e., changes in factor productivity affecting the whole economy, has long been disputed in the macroeconomic literature, see e.g. These shocks are not directly observed, and are hard to identify. Identification of technology shocks with the use of Solow residuals, for example, suffers from issues regarding the measurement of inputs and outputs, such as composition effects and variable capacity utilization.

Results

Discussion

Conclusion