Does demand noise matter? Identification and implications

Kenza Benhima (1, 2) , Céline Poilly (3)

1 UNIL - Université de Lausanne = University of Lausanne
2 CEPR - Center for Economic Policy Research
3 AMSE - Aix-Marseille Sciences Economiques

We assess the role of demand noise (excessive optimism or pessimism about demand) together with supply noise (excessive optimism or pessimism about supply). To do so, we propose a methodology to decompose business cycles into supply, demand, supply noise and demand noise shocks, using a structural vector autoregression model. Key to our identification of both supply noise and demand noise is the use of sign restrictions on survey expectation errors about output growth and about inflation. We show that demand-related noise shocks have a negative effect on output and contribute substantially to its fluctuations. Monetary policy and private information seem to play a key role in the transmission of demand noise shocks.

Keywords: business cycle; information friction; noise shock; SVAR with sign restriction

Domains: Humanities and Social Sciences; Economics and Finance

Kenza Benhima, Céline Poilly. Does demand noise matter? Identification and implications. Journal of Monetary Economics, 2021, 117, pp.278-295. ⟨10.1016/j.jmoneco.2020.01.006⟩. ⟨hal-03173423⟩