On the permanent effect of an aggregate demand shock: Evidence from the G-7 countries

This paper extends the work of Cover, Enders and Hueng (2006) to examine the idea that an aggregate demand shock may have permanent effect on the output level by indirectly shifting the aggregate supply curve. We utilize the bivariate SVAR modeling and adopt an identification scheme, which allows for the possibility that a shift in the aggregate demand curve may induce the long-run aggregate supply curve to shift. We have shown that aggregate supply shocks are positively affected by the demand shocks in each of the G-7 countries. It is found that a one-time positive aggregate demand shock increases the output level permanently in these industrialized economies. We have also shown that our decomposition strategy can help resolve anomalies in the responses of inflation to a positive aggregate supply shock observed in a simple Blanchard-Quah decomposition.     

Supply and demand factors in the output decline in East and Central Europe

What are the relative weights of supply and demand factors in generating the output declines observed in Poland during its transition to the market? And how important are the factors that fit under the rubric of “supply and demand” in comparison to other potential reasons for the output decline, especially adjustment away from the Soviet-style economic system? The initial decline seems to have been due to a combination of aggregate demand shocks associated with the stabilization, declines in inventory investment due to the transition from a shortage economy, and especially shifts in demand away from socialized sector industry towards other sectors of the economy. Growth has come primarily from expansion in new sectors, such as services and residential construction, and in new enterprises. The applicability of one-good macroeconomics is limited in understanding either the output decline or the subsequent growth in Poland.     

Endogenous growth and changing sectoral composition in advanced economies

We study how changing sectoral composition in employment and output shares affects aggregate growth by modeling a two-sector economy with a technologically “progressive” industry, which produces for consumption and investment, and a technologically “stagnant” industry producing only for consumption. Hence, unbalanced improvements in total factor productivity interact with changes in the composition of final demand in shaping the growth process. Within this endogenous growth framework, we show under what conditions on preferences Baumol's asymptotic stagnancy occurs. Beside studying the limiting behavior of the economy, numerical examples are presented to analyze the structural change going on along the transition path.     

Interpreting fluctuations in output growth in China

Unlike in OECD countries, fluctuations in output growth in China are not straightforward in their interpretation. On the one hand, they reflect the business cycle, which results from shocks to aggregate demand. On the other hand, they also reflect the structural transformations that have accompanied China’s transition to a market economy. Demand shocks can be identified by virtue of the persistence of their impact. This paper decomposes the variance in provincial, regional, and national output growth according to its persistence characteristics. The results suggest that during the reform period, only a minority of output growth variance can be attributed to demand shocks and business cycle fluctuations. It is also found that there is substantial heterogeneity in the persistence characteristics of output growth across provinces. Implications of the findings for macroeconomic policy are discussed.     

Oil-Price Shocks: Beyond Standard Aggregate Demand/Aggregate Supply Analysis

The author explores the problems of portraying oil-price shocks using the aggregate demand/aggregate supply model. Although oil-price shocks are the most commonly cited examples of aggregate supply shocks, they violate the model's assumption of constant relative prices (as acknowledged by the label, “oil-price shocks”). The resulting problems are effectively masked in textbook presentations by implicitly assuming that the supply shocks occur in a closed economy. However, the typical discussion is glaringly inaccurate when discussing the effects of oil-price shocks on oil-rich countries. Thus, the cogency of the standard model's representation of oil-price shocks on open economies is compromised. A simple modification of the model that differentiates between production and absorption goods enables it to better reflect the effects of oil-price shocks on open economies.     

The Dynamics of Inflation and Employment in the Full-Employment Zone: A Theoretical Analysis*

The paper is concerned with an economy in which some sectors reach full employment before others as demand expands. The position of short-run equilibrium of employment and excess demand is determined by the intersection of the aggregate demand schedule and the short-run output function, which shows the level of output induced by different levels of aggregate demand. The dynamics of the short-run equilibrium position are explored. It is shown that equilibrating forces due to relative price changes must predominate over disequilibrating forces due to the redistribution of income, in the absence of exogenous shocks and induced cost inflation. The latter is shown to be subject to a multiplier effect. The paper ends by drawing the policy implications of the analysis. It refutes the acceleration thesis by showing that the level of the real wage does not tend to change under excess demand and argues that if the economy is taken into the full employment zone forces will be set to work which tend to remove the bottlenecks.     

The impact of productivity and demand shocks on structural dynamics: Evidence from Austrian manufacturing

Based on Pasinetti's model of structural dynamics we develop an empirical identification strategy for aggregate and sectoral labor productivity and demand shocks in a structural vector autoregressive model with long-run restrictions. Impulse response analysis shows that we can distinguish four patterns of the effects of changes in demand and productivity growth on sectoral output growth. For some industries demand is indeed the factor driving sectoral growth. Labor productivity and demand shocks are closely associated with the growth rates of employment and output across industries. However, there is less correlation with entry and exit. This suggest that structural change within and between industries may have quite different determinants.     

Wage bargaining and shock sensitivity of a small open economy

This paper analyzes the effects of centralized bargaining over a nominal wage (indexation) rule on a small open economy with fixed exchange rates. It is shown that the relative bargaining power of the confederation of employers and the union, respectively, affects not only the level of the endogenous variables but also their reaction to exogenous disturbances. If the union's power exceeds a critical value, positive aggregate demand shocks increase unemployment since the actual nominal wage rises more than the market clearing one. Moreover, if the union's power is sufficiently close to its upper bound, the overreaction of wages becomes so large that positive aggregate demand shocks even lead to a decrease in output and employment, i.e., the multipliers become negative.     

Variability in the effects of uncertainty shocks: New stylized facts from OECD countries

This study examines variability in the effects of uncertainty shocks using a panel of international data. It first evaluates variability in the effects of uncertainty shocks by applying rolling sample and time-varying parameter Vector Autoregression models to US data covering the past 70 years. The results reveal that the effects of uncertainty shocks on the US economy have changed substantially over time. First, the negative effect of uncertainty shocks on the output decreased until the recent period, in which monetary policy rules are constrained by the zero lower bound. Second, contrary to the negative aggregate demand interpretation in the recent literature, uncertainty shocks acted as a negative aggregate supply shock in the earlier periods. From the past 50 years’ data for 12 small open economies, I find that the negative effect of uncertainty shocks on output has increased, contrary to the US case. Additionally, the exchange rate and inflation responses are heterogeneous across countries, and the country’s commodity exporter or safe haven status is critical in determining the sign of these responses. Finally, the increased vulnerability of small open economies to uncertainty shocks is associated with an increase in international trade.     

The Multi-Sector Business Cycle Model and Aggregate Shocks: An Empirical Analysis

This paper discusses the applicability of a multi-sector business cycle model to the Japanese economy. Through dynamic factor analysis, output fluctuations are broken down into aggregate and sectoral shocks. It is shown that independent sectoral shocks are more significant than common shocks, which is consistent with the model proposed by Long and Plosser (1983). In addition, the paper reveals that the importance of aggregate shocks increased during the so-called "Bubble" period in the late 1980s.     

SHOULD WE CARE ABOUT THE COMPOSITION OF TAX‐BASED STIMULUS PACKAGES?

We investigate the effects of tax policy shocks on the U.S. economy over the 1972:3–2008:4 period within a structural vector autoregressive (SVAR) framework. Disaggregating tax shocks suggests that the positive output multipliers documented for total taxes by the previous literature are present only for indirect tax innovations. We also show that both labor and corporate taxes have similar effects on output, with labor tax multipliers being slightly larger in magnitude. The positive and negative responses of inflation following respectively corporate and labor tax shocks imply that former shocks work through aggregate supply, whereas the latter work predominantly through aggregate demand. (JEL C32, E62, H20)     

“Love of wealth” and economic growth

In a Ramsey–Cass–Koopmans growth framework it is shown that for an optimum a benevolent social planner cannot have an excessive “love of wealth”. With a “right” “love of wealth” an optimum exists and implies higher long‐run per‐capita capital, income, and consumption relative to the standard model. This has important implications for comparative development trajectories. The optimum implies dynamic efficiency with the possibility of getting arbitrarily close to the golden rule where long‐run per‐capita consumption is maximal. It is shown that the optimal path attains its steady state more slowly. Thus, the beneficial effects of love of wealth materialize later than in the standard model. Furthermore, the economy can be decentralized as a competitive private ownership economy. One can then identify “love of wealth” with the “spirit of capitalism.” The paper thus implies that one needs a “right” level of the “spirit of capitalism” to realize any beneficial effects for the long run.     

Macroeconomic fluctuations: Demand or supply, permanent or temporary?

We use generalized method of moments to estimate a rational expectations aggregate demand/aggregate supply macroeconomic model for five European economies and the United States. Our aim is to examine whether supply or demand shocks have predominated in these economies during the post-war era, and whether shocks of either type have been primarily temporary or permanent in nature. We find that permanent or temporary demand shocks have been the dominant source of variance in output growth in all six countries, but there is a less consistent pattern for inflation. Permanent supply shocks had the dominant influence on autocorrelations.     

Money,Investment and Consumption: Keynes's Macroeconomics Rethought

The dominant supply-side foundation for explanations of the growth potential of an economy is losing its persuasive power in the face of persistent losses in output and employment experienced by mature economies in the aftermath of the financial crisis. There is now an opening for eclectic approaches that consider the interaction between supply-side and demand-side factors in shaping macroeconomic outcomes. In this paper, we develop a model that reflects such an approach to interpreting differential productivity growth over the long run, and then present empirical results for several countries. On the supply-side, the model considers the linkage between the intensity and efficacy of the accumulation process and the gains of productivity in terms of a Kaldorian Technical Progress Function. Then, drawing on the Evsey Domar's Keynesian notion of dynamic equilibrium as the growth rate that reconciles additions to capacity with the absorption of aggregate output by demand, we derive a locus for a ‘Domar equilibrium path’. Imbalances caused by excess aggregate supply or demand, and by the effects of ‘shocks’ are presented and discussed using a simple graphical framework. In the empirical analysis, an error-correction model is applied to the fundamental relationship between the rate of growth of product per work-hour and the rate of capital accumulation. The results suggest that the differences in productivity growth among countries are can be explained in terms of the efficiency of their ‘accumulation paths’.     

Path-dependent economic progress and regress: The negative role of subsidies in economic growth

This paper develops a two-stage economic growth model with real options and examines the effects of various subsidy policies. The economic stages are the deterministic and stochastic AK stages, and the economy may shift between the two, depending upon state variables and technological shocks. This model allows for path-dependent economic growth that accounts for both club convergence and divergence across countries. Moreover, it is shown that under certain conditions, a decrease in the subsidy rate facilitates the shift from the deterministic to stochastic AK stages, which is defined as “economic progress”, even in the face of an economic crisis, while more subsidies delay economic progress and promote the shift from the stochastic to deterministic AK stages, which is defined as “economic regress”.     

Animal spirits and the composition of innovation in a lab-equipment R&D model with transition

We study the effect of animal spirits on the composition of aggregate R&D, the consumption level and economic growth in a tournament model of horizontal and vertical R&D. By considering a full lab-equipment specification, the model predicts a positive effect of animal spirits on the balanced-growth-path (BGP) level of per-capita consumption without impacting on economic growth and on aggregate vertical R&D. However, transition is slower under “waves of enthusiasm”, implying a longer period in which growth rates are higher than the BGP level. An economy that is subject to expectations shocks then converges at a time-varying speed. On average over time, transition is longer but less “painful”—i.e., with higher per-capita consumption levels—than otherwise.     

Data uncertainty and the role of money as an information variable for monetary policy

In this study, we perform a quantitative assessment of the role of money as an indicator variable for monetary policy in the euro area. We document the magnitude of revisions to euro area-wide data on output, prices, and money, and find that monetary aggregates have a potentially significant role in providing information about current real output. We then proceed to analyze the information content of money in a forward-looking model in which monetary policy is optimally determined subject to incomplete information about the true state of the economy. We show that monetary aggregates may have substantial information content in an environment with high variability of output measurement errors, low variability of money demand shocks, and a strong contemporaneous linkage between money demand and real output. As a practical matter, however, we conclude that money has fairly limited information content as an indicator of contemporaneous aggregate demand in the euro area.     

Shocking the eurozone

In this paper, the monetary transmission mechanism within the European Monetary Union is investigated. The impulse response functions and forecast error variance decompositions of a structural vector error correction model (SVECM) are compared with those of a New Keynesian theoretical model. The identifying restrictions of the SVECM are directly derived from the theoretical model. Two permanent shocks are identified, one having only nominal, and one having only real effects. The three transitory shocks comprise a short-term interest-rate shock, an aggregate demand shock and a money demand shock. The main conclusions are that permanently reducing the inflation objective depresses output in the first year, but has no real effects in the long run. Regarding output variability, the results indicate that aggregate demand shocks are most important during the first year, after which aggregate supply shocks dominate.     

STABILIZATION POLICY AT THE ZERO LOWER BOUND

We construct a monetary economy with aggregate liquidity shocks and heterogeneous idiosyncratic preference shocks. In this environment, not all agents are satiated at the zero lower bound (ZLB) even when the Friedman rule is the best interest‐rate policy the central bank can implement. As a consequence, central bank stabilization policy, which takes the form of repo arrangements in response to aggregate demand shocks, temporarily relaxes the liquidity constraint of impatient agents at the ZLB. Due to a pecuniary externality, this policy may have beneficial general equilibrium effects for patient agents even if they are unconstrained in their money balances.     

Nominal Wage Flexibility and Economic Performance: Evidence and Implications Across Industrial Countries

By considering the theoretical connection between labour and product markets, the paper evaluates the economic relationship of these markets within the contractual wage rigidity New Keynesian explanation of business cycles. The empirical analysis focuses on the short‐run cyclical behaviour of real output, prices and wages for 19 industrial countries. Time‐series and cross‐sectional regressions are estimated. Cross‐sectional cyclical correlations in the labour and goods markets are also evaluated across countries. Consistent with the theoretical predictions, aggregate uncertainty is an important factor in increasing the flexibility of the nominal wage in response to aggregate demand shocks. Wage flexibility accelerates price inflation and moderates the response of real output growth to aggregate demand shocks. Wage flexibility does not appear to be an important factor in differentiating the real and inflationary effects of energy price shocks across countries. Finally, aggregate uncertainty increases the responsiveness of output and price to productivity shocks.