Patents, News, and Business Cycles
What this paper finds — and why it matters
This paper constructs an instrumental variable for technology news shocks using patent applications, relaxing all identifying assumptions traditionally used in the news-shock literature. The IV is the component of patent applications orthogonal to pre-existing beliefs (Survey of Professional Forecasters), contemporaneous and lagged monetary and fiscal policy changes (narrative accounts), and own lags. The instrument recovers news shocks that have no effect on aggregate productivity in the short run but are a significant driver of its trend component. The shock prompts a broad-based expansion in anticipation of the future TFP increase—output, consumption, and investment all rise well before any material increase in TFP is recorded. Despite these positive conditional co-movements, the news shock accounts for only a modest share of macroeconomic fluctuations at business cycle frequencies. Financial markets price in news shocks on impact, while most macro aggregates respond with some delay. Previously circulated as “When Creativity Strikes: News Shocks and Business Cycle Fluctuations.”
Summary of a forthcoming paper, AI-assisted and human-reviewed. See the linked original for the authoritative claims and full conditions.
Q1. What is the identification strategy and why does it relax traditional assumptions?
The paper constructs an IV for technology news shocks as the component of patent applications orthogonal to pre-existing beliefs (SPF), narrative accounts of monetary and fiscal policy, and own lags—the sole identifying assumption is that no structural disturbance other than contemporaneous technology news affects the U.S. economy through this IV. Traditional identification requires combining zero restrictions on the impact response of TFP with assumptions about its long-run drivers (e.g., Beaudry-Portier 2006 assumes news shocks are the sole long-run driver of TFP). The patent-based IV avoids all of these assumptions, relying only on the exclusion restriction that patent applications, after controlling for expectations and policy, capture news about future technological change and nothing else.
Q2. How do patent applications contain information about future technology?
Patent applications contain information about potential future technological change because exclusive rights create a powerful incentive to apply as early as possible, making patent applications lead TFP improvements by years, while controlling for contemporaneous economic conditions removes the endogeneity of patent filings to current booms. The length of time between application and the eventual diffusion of the innovation within the economy can be several years. The filing date serves as the first measurable time at which the news occurs, even though the underlying idea predates the application. The component of applications orthogonal to SPF forecasts and policy changes represents news about future technology not driven by current conditions.
Q3. What are the macroeconomic effects of technology news shocks?
Technology news shocks generate a broad-based expansion—output, consumption, and investment all rise well before any material increase in TFP is recorded—and financial markets price in news shocks on impact, while most macro aggregates respond with some delay. The positive conditional co-movements are consistent with optimism about future income and productivity generating pre-emptive expansion. Despite these theoretically attractive features, the news shock accounts for only a modest share of macroeconomic fluctuations at business cycle frequencies.
Q4. What does the modest share of variance explained imply?
The finding that news shocks account for only a modest share of macro fluctuations at business cycle frequencies implies that, while identified news shocks behave consistently with the news-driven business cycle hypothesis in qualitative terms, they contribute only modestly to aggregate volatility—a finding that differs from models in which news shocks are a primary driver of cycles. This quantitative finding is informative precisely because the identification is instrument-based and free of the theoretical priors imposed by traditional sign-restriction and FEVD approaches, lending credibility to it as an estimate of the true importance of news shocks.
Key concepts
technology news shock : a shock that raises expectations about future aggregate TFP growth without any immediate change in current TFP; the paper’s IV identifies shocks that have no short-run effect on TFP but are a significant driver of its trend component. patent-based instrument : the component of patent applications orthogonal to pre-existing macroeconomic beliefs (SPF), contemporary monetary and fiscal policy changes (narrative accounts), and own lags; used as an IV for technology news shocks that avoids traditional identifying restrictions. news-driven business cycle hypothesis : the proposition that economic fluctuations can arise from changes in agents’ expectations about future fundamentals (particularly future productivity) even absent any current change in those fundamentals; the paper finds qualitative support but only modest quantitative importance.