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TECHNOLOGY SHOCKS AND BUSINESS CYCLES IN INDIA

  • Shesadri Banerjee (a1) and Parantap Basu (a2)
Abstract

In this paper, we develop a small open economy New Keynesian dynamic stochastic general equilibrium (DSGE) model to understand the relative importance of two key technology shocks, Hicks neutral total factor productivity (TFP) shock and investment specific technology (IST) shock for an emerging market economy like India. In addition to these two shocks, our model includes three demand side shocks such as fiscal spending, home interest rate, and foreign interest rate. Using a Bayesian approach, we estimate our DSGE model with Indian annual data for key macroeconomic variables over the period of 1971–2010, and for subsamples of pre-liberalization (1971–1990) and post-liberalization (1991–2010) periods. Our study reveals three main results. First, output correlates positively with TFP, but negatively with IST. Second, TFP and IST shocks are the first and the second most important contributors to aggregate fluctuations in India. In contrast, the demand side disturbances play a limited role. Third, although TFP plays a major role in determining aggregate fluctuations, its importance vis-à-vis IST has declined during the post liberalization era. We find that structural shifts of nominal friction and relative home bias for consumption to investment in the post-liberalization period can account for the rising importance of the IST shocks in India.

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Corresponding author
Address correspondence to: Parantap Basu, Durham University Business School, Durham University, Mill Hill Lane, DH1 3LB, Durham, UK; e-mail: parantap.basu@durham.ac.uk.
Footnotes
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This paper is an extension of an earlier working paper (WP 109) available on the website of National Council of Applied Economic Research. We are grateful to the Canadian International Development Research Centre for sponsoring this project generously. We are grateful to two referees for very insightful comments which significantly enriched this paper. Thanks are also due to the participants of the International Growth and Development Conference in the Indian Statistical Institute, New Delhi in 2015 and the AIEFS participants at the ASSA conference in Chicago in 2017 for useful comments. The first author also gratefully acknowledges the feedback from the internal workshop at the Centre for Studies in Social Sciences, Calcutta. Yongdae Lee and Ajaya Sahu are gratefully acknowledged for very competent research assistance. The usual disclaimer applies.

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References
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Macroeconomic Dynamics
  • ISSN: 1365-1005
  • EISSN: 1469-8056
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