Investment-specific technology shocks and business cycle: evidence from a sign restriction approach

What constitutes the sources of business cycle fluctuations remains a long-standing debate in macroeconomics literature. While the dominant view has been that the shocks to neutral technology largely account for the fluctuations in macroeconomic aggregates, the literature has also garnered evidence favoring investment-specific technology (IST) shocks, which can be of home-grown or foreign origin. Previous empirical research has primarily investigated the former component of IST shocks and thus has been silent on the latter. This study fills a decent gap in the literature by exploring the importance of the IST shocks originating in the “Rest of the World (ROW)” in the business cycle fluctuations of Bangladesh. This study estimates a Structural Vector Autoregression (SVAR) model in the Bayesian fashion using the sign restrictions approach to disentangle three structural shocks. The findings suggest that IST shock generates statistically significant impulse responses of GDP, consumption, and investment. The forecast error variance decomposition indicates that IST shock accounts for non-trivial percentages of output, consumption, and investment dynamics relative to neutral technology shock. Neutral technology shock remains the leading cause of aggregate fluctuations. Further analysis reveals that the findings are robust to SVAR model specification and choice of priors on the reduced-form parameters. Overall, our findings are significant in understanding the spillover of technology shocks across borders and their importance in the domestic economy.