Source of Output dynamics in USA vs. Great Britain: supply, demand or nominal shocks

Abstract

The purpose of the present paper is to extend Clarida and Gali (1994) from structural specification to common trend specification and to study the relative importance of nominal, supply and demand shocks in relative output dynamics. Using their long run restrictions for given cointegration vectors, we can identify number of permanent shocks assumed to affect long run dynamics of real activity and estimate the common trend model. From the estimated model we analyze source of output dynamics in USA vs. Great Britain during 1950-2004. The common trend analysis indicates that supply shock is more important than others shocks to explain real activity dynamics and confirms stylized fact of real business cycle theory.Supply Shock; Demand Shocks; Nominal Shocks; Output Dynamics; Common Trend Model