The Main Business Cycle Shock(S). Frequency-Band Estimation of the Number of Dynamic Factors

Abstract

We introduce a novel estimator for the number of common dynamic shocks for large dynamic
factor models. The noticeable feature of our estimator is that it can be applied to single frequencies as well as to given frequency bands, making it extremely suited to disentangle the shocks aacting the macroeconomy at the business cycle frequencies, in the long run, and at any frequency band of interest. We establish consistency of our estimator in large panels and evaluate its nite-sample performance with Monte Carlo simulations. We apply our estimator to the FRED-QD US data set and nd that the US macro economy is driven by two main shocks. One of them has the features of a demand shock and the other of a supply shock. The demand shock
explains most of the cyclical fluctuations of the main macroeconomic aggregates.

Keywords: Generalized Dynamic Factor Models, Number of Dynamic Factors, Frequency Bands, Business Cycle, Permanent Component

JEL Classification: C01, C13, C38.