Creator: Chari, V. V., Kehoe, Patrick J., and McGrattan, Ellen R. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 364 Abstract:
The central finding of the recent structural vector autoregression (SVAR) literature with a differenced specification of hours is that technology shocks lead to a fall in hours. Researchers have used this finding to argue that real business cycle models are unpromising. We subject this SVAR specification to a natural economic test and show that when applied to data from a multiple-shock business cycle model, the procedure incorrectly concludes that the model could not have generated the data as long as demand shocks play a nontrivial role. We also test another popular specification, which uses the level of hours, and show that with nontrivial demand shocks, it cannot distinguish between real business cycle models and sticky price models. The crux of the problem for both SVAR specifications is that available data require a VAR with a small number of lags and such a VAR is a poor approximation to the model’s VAR.
Keyword: Vector autoregressions, Real business cycle, Impulse response, and Technology shocks Subject (JEL): E32 - Business Fluctuations; Cycles, C51 - Model Construction and Estimation, E20 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy: General (includes Measurement and Data), E13 - General Aggregative Models: Neoclassical, E30 - Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data), E37 - Prices, Business Fluctuations, and Cycles: Forecasting and Simulation: Models and Applications, and C32 - Multiple or Simultaneous Equation Models: Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models