On Econometric Analysis of Structural Systems with Permanent and Transitory Shocks and Exogenous Variables

This paper considers the implications of the permanent/transitory decomposition of shocks for identi…cation of structural models in the general case where the model might contain more than one permanent structural shock. It provides a simple and intuitive generalization of the in‡uential work of Blanchard and Quah (1989), and shows that structural equations for which there are known permanent shocks must have no error correction terms present in them, thereby freeing up the latter to be used as instruments in estimating their parameters. The proposed approach is illustrated by a re-examination of the identi…cation scheme used in a monetary model by Wickens and Motta (2001), and in a well known paper by Gali (1992) which deals with the construction of an IS-LM model with supply-side e¤ects. We show that the latter imposes more short-run restrictions than are needed because of a failure to fully utilize the cointegration information. JEL Classi…cations: C30, C32, E10 Key Words: Permanent shocks, structural identi…cation, error correction models, IS-LM models. The research of the …rst author was supported by ARC Grant DP0449659.