Macroeconomic Fluctuations in the United States: Demand or Supply, Permanent or Temporary?

We use generalized method of moments to estimate a rational expectations aggregate demand/aggregate supply macroeconomic model for the US economy. Variants of the model have been extensively used in analyses of optimal monetary policy under rational expectations. Our aim is to examine whether supply or demand shocks have predominated in the postwar 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 either of the Bernanke-Sims variety or of the Blanchard-Quah variety or to performing calibration exercises. We find that permanent nominal demand shocks are the predominant source of variance in output growth in the U.S., while permanent supply shocks are the main source of inflation variance and longer run autocorrelation of, and cross correlations between, output growth, inflation and interest rate changes. Temporary real shocks to demand are sizeable, and particularly important as a source of variance for changes in interest rates. JEL classification: E32, C32