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The Time Varying Effects of Permanent and Transitory Shocks to Real Output

John Keating and Victor (Vic) Valcarcel

No 201203, WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS from University of Kansas, Department of Economics

Abstract: Annual changes in volatility of U.S. real output growth and inflation are documented in data from 1870 to 2009 using a time varying parameter VAR model. Both volatilities rise quickly with World War I and its aftermath, stay relatively high until the end of World War II and drop rapidly until the mid to late-1960s. This Postwar Moderation represents the largest decline in volatilities in our sample, much greater than the Great Moderation that began in the 1980s. Fluctuations in output growth volatility are primarily associated with permanent shocks to output while fluctuations in inflation volatility are primarily accounted for by temporary shocks to output. Conditioning on temporary shocks, inflation and output growth are positively correlated. This finding and the ensuing impulse responses are consistent with an aggregate demand interpretation for the temporary shocks. Our model suggests aggregate demand played a key role in the changes in inflation volatility. Conversely, the two variables are negatively correlated when conditioning on permanent shocks, suggesting that these disturbances are associated primarily with aggregate supply. Our results suggest that aggregate supply played an important role in output volatility fluctuations. Most of the impulse responses support an aggregate supply interpretation of permanent shocks. However, for the pre-World War I period, we find that at longer horizons a permanent increase in output is generally associated with an increase in the price level that is frequently statistically significant. This evidence suggests aggregate demand may have had a long-run positive effect on output during the pre-World War I period.

Keywords: The Great Moderation; stochastic volatility; permanent-transitory decompositions; Markov Chain Monte Carlo; structural vector autoregressions. (search for similar items in EconPapers)
JEL-codes: E30 E31 E65 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2012-02
New Economics Papers: this item is included in nep-bec and nep-mac
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Journal Article: THE TIME-VARYING EFFECTS OF PERMANENT AND TRANSITORY SHOCKS TO REAL OUTPUT (2015) Downloads
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