Working Paper: NBER ID: w21010
Authors: Andrei A. Levchenko; Nitya Pandalainayar
Abstract: We propose a novel identification scheme for a non-technology business cycle shock, that we label "sentiment." This is a shock orthogonal to identified surprise and news TFP shocks that maximizes the short-run forecast error variance of an expectational variable, alternatively a GDP forecast or a consumer confidence index. We then estimate the international transmission of three identified shocks – surprise TFP, news of future TFP, and "sentiment" – from the US to Canada. The US sentiment shock produces a business cycle in the US, with output, hours, and consumption rising following a positive shock, and accounts for the bulk of short-run business cycle fluctuations in the US. The sentiment shock also has a significant impact on Canadian macro aggregates. In the short run, it is more important than either the surprise or the news TFP shocks in generating business cycle comovement between the US and Canada, accounting for up to 50% of the forecast error variance of Canadian GDP and about one-third of Canadian hours, imports, and exports. The news shock is responsible for some comovement at 5-10 years, and surprise TFP innovations do not generate synchronization.
Keywords: business cycles; international transmission; sentiment shocks; TFP shocks
JEL Codes: E32; F41; F44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Sentiment shock (E32) | US GDP (E20) |
| Sentiment shock (E32) | US consumption (E20) |
| Sentiment shock (E32) | US hours worked (J22) |
| Sentiment shock (E32) | Canadian GDP (N12) |
| Sentiment shock (E32) | Canadian hours worked (J38) |
| Sentiment shock (E32) | Canadian trade flows (F10) |
| Surprise TFP shock (F16) | Canadian GDP (N12) |
| Surprise TFP shock (F16) | Canadian hours worked (J38) |
| News shock (G14) | Canadian GDP (N12) |
| News shock (G14) | Canadian hours worked (J38) |