Abstract

The real and nominal shocks in the U.S. are identified by using long-run implications of an open economy stochastic macroeconomic model, and the effects of these shocks are observed in real GDP, effective exchange rates, and the prices for the U.S. relative to each of six other G-7 countries. While Blanchard and Quah’s long-run identification strategy is used to identify the shocks, short-run implication of the model are also exploited, as a prima facie evidence, by applying appropriate sign restrictions in the VAR estimation. Consistent with the model’s predictions, a positive supply shock results in an increase in relative U.S. real GDP and a real depreciation of U.S. currency whereas nominal shocks in the U.S. lead to an increase in relative U.S. real GDP and relative U.S. prices. The application of short-run dynamics with proper sign restrictions into the VAR estimation produces exchange rate overshooting following the U.S. real shocks.

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