Sectoral Contagion: A Dynamic Factor Analysis of the Great Recession

Martin, Vance; Li, Nan

Sectoral Contagion: A Dynamic Factor Analysis of the Great Recession

No 1087, 2014 Meeting Papers from Society for Economic Dynamics

Abstract: This paper studies the transmission of aggregate and sectoral shocks across different nonfarm business sectors based on dynamic factor methods. We distinguish between an underlying fundamental aggregate shock that drives business cycles throughout and an additional aggregate shock that only emerges during the Great Recession. We find this emerging common factor essentially drives a wedge between the financial service sector from the rest of the economy (we call it a `finance wedge'). Moreover, different from previous findings based on only manufacturing data, aggregate fluctuations come in large part from sector-specific shocks (augmented by amplification mechanisms). During the crisis, however, the finance wedge by itself accounts for more than half of aggregate volatility. To allow for the contemporaneous propagation of sectoral shocks, we also consider a multi-sector growth model to explicitly incorporate input-output (I-O) linkages in the factor analysis. The structural factor analysis suggests that the I-O network, although commonly perceived to be crucial in propagating sectoral shocks, falls short of generating substantial spillovers across sectors.

Date: 2014
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed014:1087

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