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Title: Macroeconomic Shocks and the Business Cycle: Evidence from a Structural Factor Model

Author(s): Mario Forni and Luca Gambetti

Publication Date: February 2010

Keyword(s): demand, fiscal policy, monetary policy, sign restrictions, structural factor model and supply

Programme Area(s): International Macroeconomics

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 six. Focusing on the four-shock specification, we identify, using sign restrictions, two non-policy shocks, demand and supply, and two policy shocks, monetary and fiscal. 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) Policy matters: Both monetary and fiscal policy shocks have sizeable effects on output and prices, with little evidence of crowding-out; 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.

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Bibliographic Reference

Forni, M and Gambetti, L. 2010. 'Macroeconomic Shocks and the Business Cycle: Evidence from a Structural Factor Model'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=7692