The dynamic effects of aggregate demand and supply disturbances in the G7 countries

This paper uses post-World War II and pre-World War I data on output and the unemployment rate from the G7 countries to estimate Blanchard and Quah's (1989) model. Their model is identified by assuming that permanent movements in output obtain from aggregate supply shocks and that aggregate demand shocks have temporary effects on output. We find that these demand shocks typically explain more output variance in the post-World War II period than in the pre-World War I period. This result is consistent with the view that price adjustment was slower in the latter half of the twentieth century. A second finding is that supply shacks cause the unemployment rate to rise for some countries and fall for others. This result implies that at least two different kinds of supply shocks are at work. However, if a country is subject to various kinds of supply shocks which have qualitatively different effects on the unemployment rate, Blanchard and Quah have shown that their model is unable to identify structural effects. The paper concludes by discussing implications of this result for macroeconometric research.