Sources of Business Cycle Fluctuations

What shocks account for the business cycle frequency and long-run movements of output and prices? This paper addresses this question using the identifying assumption that only supply shocks, such as shocks to technology, oil prices, and labor supply affect output in the long-run. Real and monetary aggregate demand shocks can affect output, but only in the short-run. This assumption sufficiently restricts the reduced form of key macroeconomic variables to allow estimation of the shocks and their effect on output and price at all frequencies. Aggregate demand shocks account for about 20 percent to 30 percent of output fluctuations at business cycle frequencies. Technological shocks account for about 1/4 of cyclical fluctuations, and about 1/3 of output's variance at low frequencies. Shocks to oil prices are important in explaining episodes in the 1970s and 1980s. Shocks that permanently affect labor input account for the balance of fluctuations in output, namely, about half of its variance at all frequencies.