Real Supply Shocks Research Articles

Demand Shocks and Trade Balance Dynamics

This paper studies the trade balance dynamics in the G-7 countries plus Spain. We estimate a SVAR model to identify three different shocks: real supply shocks, real demand disturbances and nominal shocks. A microfounded stochastic open-economy model is built to derive the long-term identification restrictions. Estimates show that real demand shocks explain most of the variability of trade imbalances, whereas, contrary to previous findings, nominal shocks play a very limited role. These results are consistent with the predictions of a widely set of open-economy models and illustrate that demand policies are the main responsible of trade imbalances.

Real supply shocks and the money growth–inflation relationship

This paper analyzes how real supply shocks affect monetary policy. Although it is widely accepted that money growth and inflation are one-to-one related in the long run, short run deviations are usually the case. Theoretically, we analyze whether such short run deviations can be attributed to global real supply shocks impinging on the economy, and empirically we provide evidence in favor of this hypothesis as well confirming that the money growth rate and inflation is one-to-one related in the long run for the United States.

Staggered Prices and Inventories: Production Smoothing Reconsidered

Staggered nominal price setting introduces predictable sales variations at the firm level. We study the implications of staggered prices in a framework where, because of increasing marginal cost, firms use inventories to smooth production and thereby separate sales from production. Conventional criticisms of production smoothing models have focused on their inability to replicate the following two stylized facts: (1) production is more volatile than sales, and (2) inventory investment is positively correlated with sales. In contrast, we show that a standard production smoothing model of inventory behavior is consistent with these facts when prices are sticky. Moreover, these results hold irrespective of whether the economy is driven by nominal demand or real supply shocks. It has also been suggested that increasing short run marginal cost at the firm level can make the effects of nominal shocks more persistent. We show that if firms can hold inventories, nominal demand shocks will have persistent effects on sales, but not necessarily on production.

The Implications of Wage Indexation on the Magnitude of Macroeconomic Fluctuations in a Simple Closed Economy

This article re-examines the issue of whether wage indexation may or may not accentuate the fluctuations of macroeconomic aggregates upon the occurrence of aggregate random shocks. Previous contributions on the macroeconomic implications of wage indexation were elaborated by several authors, including Gray [8], Fischer [6], and Cukierman [4]. Gray and Fischer developed frameworks that are closed to exchanges with the rest of the world and concluded that the effects of wage indexation on the magnitude of macroeconomic fluctuations differ according to whether the initial disturbance stems from nominal or real factors. In particular they showed that full indexation of nominal wages to the general level of prices will exacerbate the real effects of real supply shocks while insulating the economy from monetary disturbances. The model specified by Gray and Fischer assumed that employment is demand determined, and, as Cukierman has pointed out, this assumption is arbitrary. Accordingly, Cukierman extended Gray's model and demonstrated that the effects of wage indexation on macroeconomic fluctuations depend on whether it is the demand or the supply of labor which is the dominant component in the determination of employment. More specifically, he established that complete indexation of wages to prices may, contrary to what Gray and Fischer demonstrated, stabilize the effects of real supply shocks, when the supply of labor is the dominant factor in the determination of employment. The existing literature on wage indexation and macroeconomics assumes, a) that shocks across markets are not linked with each other, b) that generally the nominal wage rate is tied only to the price level and c) monetary policy is passive. The analysis in this paper is based on an extension of the models Gray and Cukierman put forth. First, we introduce in the model the concept of a Walrasian budget constraint.' The Walrasian budget constraint specifies that an aggregate shock in the demand for goods may be offset by an increase in the supply of labor,

Arima and Cointegration Tests of PPP under Fixed and Flexible Exchange Rate Regimes

Real exchange rates between the United States and its major trading partners were calculated for the Bretton Woods and flexible exchange rate periods. Unit root tests indicate that Purchasing Power Parity performed poorly in both periods. Tests for cointegration reveal limited instances in which it is possible to estimate the deviations from PPP as an error correcting model. The estimated error correcting models indicate that foreign, but not U.S., prices responded to deviations from PPP. Frenkel's (1981b) finding that Purchasing Power Parity (PPP) worked better during the 1920s than the 1970s caused considerable controversy. For example, Davutyan and Pippenger (1985) contend that the socalled collapse of PPP is a result of an increase in the relative importance of real versus monetary shocks. They argue that the 1970s, as opposed to the 1920s, was characterized by real supply shocks and the international coordination of monetary policies. The argument is that PPP did not fail; rather, there was an increase in the volatility of those factors giving rise to deviations from PPP. Hakkio (1984) reestimated PPP over the 1920s and 1970s; using cross-country tests (i.e., SURE estimates) to improve the efficiency of his estimates, he was able to support the hypothesis that PPP worked better in the 1970s than in the 1920s. On the other hand, papers by Adler and Lehman (1983), Dornbusch (1980), Frenkel (1981a), Junge (1985), and Krugman (1978) report findings contrary to the PPP hypothesis. Moreover, Kenen and Rodrik (1986) find that the volatility of real exchange rates has increased throughout the flexible rate period. This paper tries to shed some light on the importance and persistence of the observed deviations from Purchasing Power Parity under alternative exchange rate systems. While it is interesting to compare PPP in the 1920s versus the 1970s, it is equally useful to compare the 1960s versus the 1970s and 1980s. If real supply shocks and lack of monetary coordination are characteristic of the latter period, PPP should perform better in the 1960s. To illustrate the issues involved, consider the following econometric model of (Relative) Purchasing Power

Are productivity fluctuations due to real supply shocks?

Shapiro (1987) draws support for real business cycle theories from the behavior of cost-based and output-based measures of productivity. This evidence is examined and shown to rely on spurious correlations.