Macroeconomic shocks and business cycles in Australia

A small vector autoregression model is estimated to assess how demand and supply shocks influence Australian output and price behavior. The model is identified by assuming that aggregate demand shocks have transitory effects on output, while aggregate supply shocks have permanent effects. The paper describes how Australian macroeconomic variables respond to demand and supply shocks in the short run and in the long run. It also finds that demand shocks are dominant in determining fluctuations in Australian output at a one-quarter horizon, but supply shocks assume the larger role at longer horizons. Supply shocks also account for most of the fluctuations in the Australian price level.