Productivity shocks and real business cycles

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Abstract

Productivity shocks play a central role in real business cycles as an exogenous impulse to macroeconomic activity. However, measured Solow-Prescott residuals do not behave as an exogenous impulse. Rather, econometric evidence provided in this paper indicates that (1) money, interest rates, and government spending Granger-cause these impulses, and (2) a substantial component of the variance of these impulses (between one quarter and one half) is attributable to variations in aggregate demand. These results are robust to a number of econometric issues, including measurement errors, specification of the production function, and certain forms of omitted real variables.

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    This paper has evolved from Chapter 2 of my Carnegie Mellon Ph.D. dissertation. I thank my committee members, Bennett McCallum (chairman), Martin Eichenbaum, Albert Marcet, and also Toni Braun, Robert Clower, Finn Kydland, the editors of this Journal, and an anonymous referee for helpful comments. I alone am responsible for any errors. The views expressed in this paper are solely those of the author and do not necessarily represent those of the Federal Reserve Bank of Chicago or the Federal Reserve System.

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