DP3844 | Stock Prices, News and Economic Fluctuations

Publication Date

23/03/2003

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Abstract

A common view in macroeconomics is that business cycles can be meaningfully decomposed into fluctuations driven by demand shocks - which are shocks that have no short- or long-run effects on productivity - and fluctuations driven by unexpected changes in technology. In this Paper we propose a means of evaluating this view and we show that it is strongly at odds with the data. In contrast, we show that the data favours a view of business cycles driven primarily by a shock that does not affect productivity in the short run - therefore it looks like a demand shock - but affects productivity in the long run. The structural interpretation we suggest for this shock is that it represents news about future technological opportunities. We show that this shock explains about 50% of business cycle fluctuations and therefore deserves to be acknowledged and further understood by macroeconomists.