Interpreting Permanent Shocks to Output When Aggregate Demand May Not Be Neutral in the Long Run

John W. Keating

Journal of Money, Credit and Banking, 2013, vol. 45, issue 4, 747-756

Abstract: This paper studies a popular statistical model of permanent and transitory shocks to output using a set of arguably more plausible structural assumptions. One way to structurally interpret the model is by assuming aggregate demand has no long‐run output effect. However, many economic theories are inconsistent with that assumption. Instead, we reinterpret the statistical model assuming a positive shock to aggregate supply lowers the price level and in the long run raises output while a positive shock to aggregate demand raises the price level. Under these assumptions, a puzzling finding from the empirical literature implies that a positive aggregate demand shock had a long‐run positive effect on output in pre–World War I economies.

Date: 2013
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https://doi.org/10.1111/jmcb.12023

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Persistent link: https://EconPapers.repec.org/RePEc:wly:jmoncb:v:45:y:2013:i:4:p:747-756

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