Role of Real and Monetary Disturbances on Economic Fluctuations: New Evidence

Abstract: This paper reexamines the role of real and monetary factors in economic fluctuations by analyzing how Puerto Rico's economy responds to impulses from the United States. Puerto Rico serves as an excellent case study of an open economy due to its strong economic and political ties with the United States. To identify real economic shocks, both technological and non-technological impulses, the methodology proposed by Galí (1999) using U.S. data was applied. Non-technological innovations may arise from institutional regulations affecting labor supply (Saltari and Travaglini, 2009) or from real aggregate demand (Galí and Rabanal, 2004). M2 was used as an indicator for monetary disturbances. The empirical analyses suggest that real disturbances play a more significant role in Puerto Rico's cyclical variability of aggregate production than monetary shocks. Specifically, technological disturbances account for about 18% of the forecast error variance of Puerto Rico's GNP in the long run, while non-technological innovations are responsible for almost 30% of this variation over the same forecast horizon. In contrast, little evidence was found that unexpected changes in M2 significantly contribute to the cyclical variability of real economic activity in Puerto Rico, explaining only about 5% of the Island's aggregate real production fluctuations in the long run, in the base model estimated. Furthermore, it was found that in the short run Puerto Rico's local shocks explain around 80% of the movement of the rate of growth of the real GNP of the Island. Keywords: Technological Shocks, Monetary Impulses, Business Cycle, Puerto Rico JEL Classification Number: C22 E32, E52