Sectoral vs. Aggregate Shocks: A Structural Factor Analysis of Industrial Production

Andrew T. Foerster · Pierre-Daniel G. Sarte · Mark Watson

65 citations0/0 files storedNational Bureau of Economic Research

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Abstract

This paper uses factor analytic methods to decompose industrial production (IP) into components arising from aggregate shocks and idiosyncratic sector-specific shocks.An approximate factor model finds that nearly all (90%) of the variability of quarterly growth rates in IP are associated with common factors.Because common factors may reflect sectoral shocks that have propagated by way of input-output linkages, we then use a multisector growth model to adjust for the effects of these linkages.In particular, we show that neoclassical multisector models, of the type first introduced by Long and Plosser (1983), produce an approximate factor model as a reduced form.A structural factor analysis then indicates that aggregate shocks continue to be the dominant source of variation in IP, but the importance of sectoral shocks more than doubles after the Great Moderation (to 30%).The increase in the relative importance of these shocks follows from a fall in the contribution of aggregate shocks to IP movements after 1984.

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References

2002Determining the Number of Factors in Approximate Factor Models 2002Forecasting Using Principal Components From a Large Number of Predictors 1983Real Business Cycles 1985Indivisible labor and the business cycle 2003Inferential Theory for Factor Models of Large Dimensions 2011The Granular Origins of Aggregate Fluctuations 1983Arbitrage, Factor Structure, and Mean-Variance Analysis on Large Asset Markets 1982Arbitrage, Factor Structure, and Mean-Variance Analysis on Large Asset Markets

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