Interaction between structural and cyclical shocks in production and employment

A major aim of recent empirical modelling of the business cycle is to identify the relative importance of aggregate supply and demand shocks. This paper uses the methodology of unobserved (or structural) components time series models for the identification of technology and demand shocks in a two-equation system of structural labour productivity and industrial output. It allows us to introduce the correlation between the structural and cyclical shocks such that the mutual dependency of these shocks can be estimated explicitly. The data is quarterly time series of labour productivity in industry and industrial output for Germany, the Netherlands, the United Kingdom and the United States. Our results show that the covariance of the dynamics of structural and cyclical shocks appears to be important in these countries.