Two's not company: mis-aggregation and "supply-induced" unemployment increases

Hoffmaister, Alexander W. (2022): Two's not company: mis-aggregation and "supply-induced" unemployment increases.

Abstract

The seminal work by Blanchard and Quah (1989) identifying long-run shocks finds that the unemployment rate increases following a “supply” shock. This puzzling result engenders a lively debate between leading schools of macroeconomic thought. But should we employ this model to study macroeconomic fluctuations? Faust and Leeper (1997) warn that the model is not reliable for structural inference, nor is the related Bayoumi and Eichengreen (1993) model. In this paper, I revisit the disputed result from the viewpoint of IRF’s bias. Using a novel methodology to parse the sources of IRF’s bias, I find that “supply-induced” unemployment increases reflect mis-aggregation of technology and labor-supply shocks.

• Item Type: MPRA Paper
• Language: English
• Keywords: vector autoregression; permanent and temporary shocks to output; missing-variables; fundamentalness; mis-aggregated shocks; co-mingled shocks; impulse response function bias; moving-average representation; aggregate demand and supply shocks; long-run neutrality; labor-supply shocks; contractionary technology shocks
• Subjects: C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C32 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes ; State Space Models; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C52 - Model Evaluation, Validation, and Selection; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles

References

Ball, Laurence, N. Gregory Mankiw, and David, Romer, 1988, “The New Keynesian Economics and the Output-Inflation Trade-off, Brookings Papers on Economic Activity, Vol 1, pp. 1–82.

Barnichon, Regis, 2010, “Productivity and Unemployment over the Business Cycle,” Journal of Monetary Economics, Vol. 57, pp. 1013–25.

Basu, Susanto, John Fernald, and Miles Kimball, 2006, “Are Technological Improvements Contractionary?,” American Economic Review, Vol. 96, pp. 1418–48.

Basu, Susanto, John Fernald, Jonas Fisher, and Miles Kimball, 2013, “Sector-specific Technical Change,” Manuscript, Federal Reserve Bank of San Francisco.

Bayoumi, Tamin, and Barry Eichengreen, 1993, “Shocking Aspects of European Monetary Unification,” in Francesco Torres and Francesco Giavazzi eds, Adjustment and Growth in the European Monetary Union, Cambridge: Cambridge University Press, pp. 193–229.

Bayoumi, Tamin, and Barry Eichengreen, 1994, “Macroeconomic Adjustment Under Bretton Woods and the Post-Bretton-Woods Float: An Impulse-Response Analysis,” The Economic Journal, Vol. 104, pp. 813 –27.

Bayoumi, Tamin, and Barry Eichengreen, 2020, “Aftershocks of Monetary Unification: Hysteresis with a Financial Twist,” Journal of Banking and Finance, Vol. 113, pp. 1–13.

Beaudry, Paul, Patrick Feve, Alain Guay, and Franck Portier, 2019, “When is fundamentalness in SVARs a real problem,” Review of Economic Dynamics, Vol. 34, pp. 221–43.

Binet, Marie-Estelle, and Jean-Sebastien Pentecote, 2015, “Macroeconomic idiosyncrasies and European Monetary Unification: A Skeptical Long Run View,” Economic Modelling, Vol. 51, pp. 412–23.

Blanchard, Olivier Jean, 1989, “A Traditional Interpretation of Macroeconomic Fluctuations,” American Economic Review, Vol. 79, pp. 1146–64.

Blanchard, Olivier Jean, and Danny Quah, 1989, “The Dynamic Effects of Aggregate Demand and Supply Disturbances,” American Economic Review, Vol. 79, pp. 655–73.