Working Paper: CEPR ID: DP14365
Authors: Kenza Benhima; Cline Poilly
Abstract: We assess the role of demand noise (excessive optimism or pessimism about demand) together with supply noise (excessive optimism or pessimism about supply). To do so, we propose a methodology to decompose business cycles into supply, demand, supply noise and demand noise shocks, using a structural vector autoregression model. Key to our identification of both supply noise and demand noise is the use of sign restrictions on survey expectation errors about output growth and about inflation. We show that demand-related noise shocks have a negative effect on output and contribute substantially to its fluctuations. Monetary policy and private information seem to play a key role in the transmission of demand noise shocks.
Keywords: business cycle; information friction; noise shock; SVAR with sign restrictions
JEL Codes: E32; D82; C32; E31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| demand noise shocks (E39) | output (C67) |
| supply noise shocks (Q43) | output (C67) |
| demand noise shocks (E39) | inflationary pressure (E31) |
| inflationary pressure (E31) | central bank raises interest rates (E52) |
| central bank raises interest rates (E52) | aggregate demand (E00) |
| persistent demand shocks (E32) | demand noise effects on output (C69) |