Working Paper: NBER ID: w14389
Authors: Andrew T. Foerster; Pierre-Daniel G. Sarte; Mark W. Watson
Abstract: This paper uses factor analytic methods to decompose industrial production (IP) into components arising from aggregate shocks and idiosyncratic sector-specific shocks. An approximate factor model finds that nearly all (90%) of the variability of quarterly growth rates in IP are associated with common factors. Because common factors may reflect sectoral shocks that have propagated by way of input-output linkages, we then use a multisector growth model to adjust for the effects of these linkages. In particular, we show that neoclassical multisector models, of the type first introduced by Long and Plosser (1983), produce an approximate factor model as a reduced form. A structural factor analysis then indicates that aggregate shocks continue to be the dominant source of variation in IP, but the importance of sectoral shocks more than doubles after the Great Moderation (to 30%). The increase in the relative importance of these shocks follows from a fall in the contribution of aggregate shocks to IP movements after 1984.
Keywords: Industrial Production; Aggregate Shocks; Sectoral Shocks; Factor Analysis; Great Moderation
JEL Codes: C32; E23; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| aggregate shocks (E10) | variability in IP (L15) |
| sectoral shocks (F41) | variability in IP (L15) |
| reduction in aggregate shock variability (E19) | increase in sector-specific shocks influence (F69) |
| input-output linkages (D57) | propagation of sector-specific shocks (F41) |
| propagation of sector-specific shocks (F41) | aggregate output variability (E23) |