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

FRB Richmond Working Paper No. 08-07

38 Pages Posted: 11 Dec 2012

See all articles by Andrew T. Foerster

Andrew T. Foerster

Federal Reserve Banks - Federal Reserve Bank of San Francisco

Pierre-Daniel G. Sarte

Federal Reserve Bank of Richmond

Mark W. Watson

Princeton University - Woodrow Wilson School of Public and International Affairs; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: November 1, 2008

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.

Keywords: input-output matrix, Great Moderation, approximate factor model

JEL Classification: E32, E23, C32

Suggested Citation

Foerster, Andrew T. and Sarte, Pierre-Daniel and Watson, Mark W., Sectoral vs. Aggregate Shocks: A Structural Factor Analysis of Industrial Production (November 1, 2008). FRB Richmond Working Paper No. 08-07. Available at SSRN: https://ssrn.com/abstract=2187904 or http://dx.doi.org/10.2139/ssrn.2187904

Andrew T. Foerster

Federal Reserve Banks - Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

Pierre-Daniel Sarte (Contact Author)

Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

Mark W. Watson

Princeton University - Woodrow Wilson School of Public and International Affairs ( email )

Princeton University
Princeton, NJ 08544-1021
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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