Why Are Beveridge-Nelson and Unobserved-Component Decompositions of GDP So Different?

James Morley · Charles R. Nelson · Eric W. Zivot

116 citations0/0 files storedRePEc: Research Papers in Economics

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Monetary Policy and Economic Impact Forecasting Techniques and Applications Unemployment and Economic Growth

Abstract

This paper reconciles two widely-used decompositions of GDP into trend and cycle that yield starkly different results. Beveridge-Nelson (BN) implies that a stochastic trend accounts for most of the variation in output, while Unobserved-Components (UC) implies cyclical variation is dominant. Which is correct has broad implications for the relative importance of real versus nominal shocks. We show the difference arises from the restriction imposed in UC that trend and cycle innovations are uncorrelated. When this restriction is relaxed, the UC decomposition is identical to the BN decomposition. Furthermore, the zero correlation restriction can be rejected for U.S. quarterly GDP, with the estimated correlation being –0.9.

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References

1989A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle 1997Postwar U.S. Business Cycles: An Empirical Investigation 1982Trends and random walks in macroeconmic time series 1981A new approach to decomposition of economic time series into permanent and transitory components with particular attention to measurement of the ‘business cycle’1988How Big Is the Random Walk in GNP?1993Detrending, stylized facts and the business cycle 1984Are Economic Time Series Asymmetric over the Business Cycle?1998Detrending and business cycle facts

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