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Fundamental Economic Shocks and The Macroeconomy

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  • Charles L. Evans
  • David A. Marshall
Abstract
Recently there has been renewed interest in assessing economic models in the context of specific, empirically identified economic shocks. Typically, these shocks are identified one-at-a-time, ignoring potential correlations across shocks, or are identified in the context of a structural vector autoregression (SVAR) using zero restrictions only loosely tied to economic theory. In this paper, we develop an alternative approach that utilizes measures of economic shocks explicitly derived from economic models to identify multiple orthogonal structural impulses. We use this approach to identify technology shocks, marginal-rate-of-substitution (labor supply) shocks, and monetary policy shocks in the context of a Factor Augmented VAR. We then examine the Bayesian posterior distribution for the responses of a large number of endogenous macroeconomic and financial variables to these three shocks.. The shocks account for the preponderance of output, productivity and price fluctuations. Technology shocks have a permanent impact on measures of economic activity, whereas the other shocks are more transitory. Labor inputs have little initial response to technology shocks, with the response building steadily over the 5 year period. Consumption’s sluggish response to the technology shock is inconsistent with a simple formulation of the permanent income hypothesis, but would be consistent with a model of habit formation. Monetary policy has a rather small response to technology shocks, but responds “leans against the wind” in response to the more cyclical labor supply shock. This more cyclical shock has the biggest impact on interest rates. Stock prices respond to all three shocks. A number of other empirical implications of our approach are discussed.

Suggested Citation

  • Charles L. Evans & David A. Marshall, 2005. "Fundamental Economic Shocks and The Macroeconomy," Working Papers Central Bank of Chile 351, Central Bank of Chile.
    • Handle: RePEc:chb:bcchwp:351
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    8. William T. Gavin & Kevin L. Kliesen, 2008. "Forecasting inflation and output: comparing data-rich models with simple rules," Review, Federal Reserve Bank of St. Louis, vol. 90(May), pages 175-192.
    9. Anthony M. Diercks & William Waller, 2017. "Taxes and the Fed : Theory and Evidence from Equities," Finance and Economics Discussion Series 2017-104, Board of Governors of the Federal Reserve System (U.S.).
    10. Jieun Lee, 2022. "Evidence and Strategy on Economic Distance in Spatially Augmented Solow-Swan Growth Model," Papers 2209.05562, arXiv.org.
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