Macroeconomic Fluctuations: Demand or Supply, Permanent or Temporary?

We use generalized method of moments to estimate a rational expectations aggregate demand/aggregate supply macroeconomic model for five European economies and the United States. Our aim is to examine whether supply or demand shocks have predominated in these economies during the post-war era, and whether shocks of either type have been primarily temporary or permanent in nature. The estimation procedure is an alternative to estimating and interpreting vector autoregressions under restrictions of the Bernanke-Sims or BlanchardQuah variety or to performing calibration exercises. We find that all four types of shocks (permanent supply, permanent demand, temporary supply, and temporary demand) are needed to account for the data on output and inflation across all economies, although in a number of economies three shocks suffice. Permanent or temporary demand shocks have been the dominant source of variance in output growth in five of the six countries, but there is a less consistent pattern for inflation. JEL classification: E32, C32