The Role of Global Shocks in Explaining US Output and Real Exchange Rate: Evidence From Unfiltered Data

Abstract

We investigate the role of global shocks in the determination of US business cycle fluctuations, with a particular focus on their relative contribution to explaining the dynamics of output and real exchange rate. To this end, we develop a two-sector open economy dynamic stochastic general equilibrium (DSGE) model with oil demand that, in addition to global shocks, also incorporates productivity, mark-up and demand shocks. Using unfiltered data, this model is estimated within an indirect inference (II) framework. Our findings reveal that global shocks are among the chief drivers of movements in many US macroeconomic aggregates, including output and the real exchange rate between 1949 and 2013. Consequently, we establish that productivity, mark-up and demand shocks alone cannot sufficiently account for the observed volatilities in the variables of interest.

JEL Classification: E32, D58, F41, C52, Q43