We use generalized method of moments to estimate a rational expectations aggregate demand-aggregate supply macroeconomic model for five European economies. Our aim is to examine whether supply or demand shocks have predominated in the major European economies during the post-war era and whether shocks of either type have been primarily temporary or permanent in nature. The estimation procedure is an alternative to estimating and interpreting vector autoregressions under restrictions either of the Bernanke-Sims variety or the Blanchard-Quah variety or to performing calibration exercises.
We find that all four types of shocks (permanent supply, permanent demand, temporary supply, and temporary demand) are needed to account for the data on output and inflation. Permanent or temporary demand shocks have been the dominant source of variance in output growth in four of the five countries, but there is no consistent pattern for inflation.
JEL classification: E32, C32
Key words: generalized method of moments, macroeconomics, rational expectations, real business cycles, Europe
The authors thank Bennett McCallum, Adrian Pagan, Will Roberds, Bart Taub, and participants in seminars at Australian National University, the University of Melbourne, Rice University, the Federal Reserve Bank of Atlanta, the Federal Reserve Bank of Richmond, the Federal Reserve System Committee on Macroeconomics, and the Western Economic Association for comments on earlier drafts. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.
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