DP14365 Does demand noise matter? Identification and implications

Author(s): Kenza Benhima, Céline Poilly
Publication Date: January 2020
Keyword(s): Business cycle, Information Friction, Noise shock, SVAR with sign restrictions
JEL(s): C32, D82, E31, E32
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14365

We assess the role of demand noise (excessive optimism or pessimism about demand) together with supply noise (excessive optimism or pessimism about supply). To do so, we propose a methodology to decompose business cycles into supply, demand, supply noise and demand noise shocks, using a structural vector autoregression model. Key to our identification of both supply noise and demand noise is the use of sign restrictions on survey expectation errors about output growth and about inflation. We show that demand-related noise shocks have a negative effect on output and contribute substantially to its fluctuations. Monetary policy and private information seem to play a key role in the transmission of demand noise shocks.