Relative Demand Shocks
University of Aarhus Economics Working Paper No. 2004-11
39 Pages Posted: 4 Nov 2004
Date Written: May 19, 2004
This paper introduces the concept of relative demand shocks into a multi-sector dynamic general equilibrium model. Relative demand shocks change the instantaneous structure of preferences. Under relative demand shocks consumer tastes randomly shift across different commodities, as manifested by unexpected relative increases or decreases in the marginal utility of the various consumption goods. There are no exogenous technology (productivity) shocks in the model. There are three main results. First, the model proposes an original theoretical mechanism for generating aggregate fluctuations and sectoral comovement by using inter-sectoral and idiosyncratic shocks. This mechanism is complementary to the standard Real Business Cycle theory. Second, the model is effectively able to reproduce the main stylized facts of the U.S. economy, also those that the standard Real Business Cycle model fails to explain. Third, the model generates a false Solow Residual, even though there is no technological progress in the model. Its size and time series properties are analogous to the actual Solow Residual.
Keywords: Demand Shocks, Two-sector Dynamic General Equilibrium Models
JEL Classification: F11, E32
Suggested Citation: Suggested Citation