Puzzling Comovements between Output and Interest Rates? Multiple Shocks are the Answer.

Stylized facts on output and interest rates in the U.S. have so far proved hard to match with business cycle models. But these ¯ndings do not acknowledge that the economy might well be driven by di®erent shocks, and by each in di®erent ways. I estimate covariances of output, nominal and real interest rate conditional on three types of shocks: Technology, monetary policy and sources of in°ation persistence. Conditional and technology and monetary policy, the results square with standard models. However these two shocks explain only about 50% of persistent movements in in°ation which are key for understanding the overall comovements. The puzzle lies in modeling the shocks and transmission channels behind in°ation persistence, not in standard transmission channels for technology and monetary policy errors.