Trends and Cycles An Historical Review of the Euro Area§

We analyze the euro area business cycle in a medium scale DSGE model where we assume two stochastic trends: one on total factor productivity and one on the in ation target of the central bank. To justify our choice of integrated trends, we test alternative speci cations for both of them. We do so, estimating trends together with the model's structural parameters, to prevent estimation biases. In our estimates, business cycle uctuations are dominated by investment speci c shocks and preference shocks of households. Our results cast doubts on the view that cost push shocks dominate economic uctuations in DSGE models and show that productivity shocks drive uctuations on a longer term. As a conclusion, we present our estimation's historical reading of the business cycle in the euro area. This estimation gives credible explanations of major economic events since 1985.