The Role of Transitory and Permanent Shocks in Business Cycle

The nature of business cycles is different in developed versus developing countries. In developed countries, business cycles are temporary and occur around the trend of long-term, sustainable growth; while in developing countries, shocks in growth trend are the main source of fluctuations. In this paper, business cycles are extracted from time series of Iran economy, being differentiated from long-term growth trend. Also, a small Dynamic Stochastic General Equilibrium (DSGE) model augmented with permanent shocks to labor productivity and temporary shocks to Total Factor Productivity (TFP) is utilized to separate the effects of shocks. Parameters of the model are estimated using Bayesian method and quarterly time series. The model with estimated parameters can closely replicate the business cycles in the economy. The results indicate that shocks to the growth trend are the main source of fluctuations in Iranian economy.