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THE TIME-VARYING EFFECTS OF PERMANENT AND TRANSITORY SHOCKS TO REAL OUTPUT

Published online by Cambridge University Press:  31 October 2014

John W. Keating  and
Victor J. Valcarcel
John W. Keating*
Affiliation:
University of Kansas
Victor J. Valcarcel
Affiliation:
Texas Tech University
*
Address correspondence to: John W. Keating, Economics Department, 334 Snow Hall, University of Kansas, Lawrence, KS 66045, USA; e-mail: jkeating@ku.edu; URL: http://www.people.ku.edu/jkeating/.
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Abstract

A time-varying-parameter VAR for real output growth and inflation is estimated with annual U.S. series dating back to 1870. Volatility for both variables rises quickly with World War I and its aftermath, stays high until the end of World War II, and drops rapidly until the 1960s. This Postwar Moderation yields the largest decline in volatilities, surpassing the Great Moderation. Conditional on temporary shocks, inflation and output growth are positively correlated. Our model implies that aggregate demand played a key role in inflation volatility fluctuations. Conversely, the two variables are negatively correlated conditional on permanent shocks. Our model suggests that aggregate supply played an important role in output volatility fluctuations. Most impulse responses support an aggregate supply interpretation for permanent shocks. However, before World War I, a permanent increase in output raised the price level at longer horizons, and these responses are frequently statistically significant. This evidence supports the hypothesis that aggregate demand had a long-run positive effect on output during the pre–World War I period.

Keywords

The Great ModerationThe Postwar ModerationStochastic VolatilityPermanent–Transitory DecompositionsMarkov Chain Monte CarloStructural Vector Autoregression
Type
Articles
Information
Macroeconomic Dynamics , Volume 19 , Issue 3 , April 2015 , pp. 477 - 507
Copyright
Copyright © Cambridge University Press 2014 

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