could potentially drive business-cycle fluctuations in the economy. These include, for example, changes in expectations on the returns to investment, government spending or tax change, commodity prices, and terms of trade changes, as well as a range of other shocks that affect aggregate demand.<sup>11</sup> To illustrate the effects of a typical business-cycle shock, the SVAR identifies the shock that drives the majority of fluctuations in investment at business-cycle frequencies. This contrasts with the long-run frequencies used to identify technology shocks. Fluctuating _animal spirits_ are often cited as the drivers of large changes in investment growth and have long been assumed to be the principal driver of the business cycle since the introduction of Keynesian economics (Justiniano et al., 2010; Keynes, 1936).<sup>12</sup> We specifically target investment to demonstrate the effects of a _demand shock_ on productivity. In contrast, we find that the shock targeting business-cycle inflation variation resembles an adverse cost-push supply shock in both advanced economies and EMDEs, while the shock targeting employment resembles a positive labor-supply shock in EMDEs and a positive demand shock in advanced economies (see Appendix A).

**Advanced economies.** A typical demand shock in advanced economies causes labor productivity to rise initially but fade after several years, in contrast to the effects of the identified technology shock (see Figure 6). This is largely due to a fall in the level of TFP after an initial boost (likely reflecting cyclical changes in utilization, as predicted). While TFP contracts from year-3 onward, the impact on labor productivity falls to zero, reflecting the offsetting effect of higher investment that boosts the capital stock. In contrast to the effect of the identified technology shock, employment initially rises, but the effect subsides. The initial boost to consumption and investment also fades over a 10-year horizon, in contrast to the persistent boost from a technology shock to these variables. Finally, consumer prices initially rise, in line with responses expected from a typical positive demand-development.

**EMDEs.** EMDEs exhibit many similar responses to a demand shock as in advanced economies, but the identified shock has more persistent effects on labor productivity. The initial boost to TFP falls away as in advanced economies. However, labor productivity remains higher as the persistent effects of higher investment raise the ratio of capital to labor. The persistently higher level of labor productivity also allows for a longer-term rise in consumption.

The finding that demand shocks can have highly persistent effects on productivity and output over the long-run has also been found in several related contexts. In advanced economies, monetary policy, which is often assumed to have neutral effects on real variables such as productivity over the long run, has been found to have highly persistent effects on capital deepening and TFP at horizons over 10 years (Jord`a et al., 2020; Moran and Queralto, 2018). Government spending shocks have

> 11A range of non-technology shocks exist, many of which are not-necessarily demand-driven. For example, a labor supply shock may result in lower consumer prices and labor productivity, as the price of labor falls relative to capital. This would contrast with the technology shock identified by the SVAR, however, which reduces the quantity of labor employed in production.

> 12Changing expectations about future innovations (“News”) has also been cited as a key driver of the business cycle, resulting in large swings in investment growth (Beaudry and Portier, 2014). In addition, demand-side factors have also been found to dominate the volatility of output in the short-run for G7 economies (den Haan and Sumner, 2004).

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