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Regime Switches in GDP Growth and Volatility: Some International Evidence and Implications for Modelling Business Cycles

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  • Penelope A. Smith

    (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne)

  • Peter M. Summers

    (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne)

Abstract

This paper has three main objectives. First, we re-examine some recent findings that suggest a structural decline in the variance of GDP growth in the United States. We estimate a univariate model in which both the mean growth rate of GDP and its variance are influenced by latent state variables that follow independent Markov chain processes. We are particularly interested in evidence of increased stability in the U.S. economy, either because of reduced volatility or a narrower gap between growth rates in expansions and recessions. Second, we investigate whether a similar phenomenon has occured in other countries. Finally, we explore the extent to which this more general model is better able to describe the shape of actual business cycles. We find evidence of a reduction in GDP volatility in U.S. data, beginning in late 1984. However, it is less clear that this change represents a structural break. The recent U.S. recession has reduced the probability of being in the low-variance state. Using data from Australia, Canada, Germany, Japan and the United Kingdom, we find evidence of a similar reduction in volatility of GDP growth. The shift for Japan apparently happened in about 1974, and the past decade's poor economic performance seems to have brought a return to the high-variance state. Apart from Germany, the variance reductions in the other countries all occurred within a ten year period between the early 1980's and the early 1990's. Finally, when we test for non-linear effects using Bayes factors, we find that allowing for a switching variance is much more important than a switching mean. Although the hypothesis of homoscedasticity is overwhelmingly rejected, there is little evidence that this model is better able to capture the shape of actual business cycles.

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Bibliographic Info

Paper provided by Melbourne Institute of Applied Economic and Social Research, The University of Melbourne in its series Melbourne Institute Working Paper Series with number wp2002n21.

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Length: 38 pages
Date of creation: Nov 2002
Date of revision:
Handle: RePEc:iae:iaewps:wp2002n21

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  1. Don Harding & Adrian Pagan, 1999. "Dissecting the Cycle," Melbourne Institute Working Paper Series, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne wp1999n13, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne.
  2. Chang-Jin Kim & Charles R. Nelson, 1999. "State-Space Models with Regime Switching: Classical and Gibbs-Sampling Approaches with Applications," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262112388, December.
  3. Christopher Sims & Tao Zha, 2002. "Macroeconomic switching," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Mar.
  4. Hess, Gregory D & Iwata, Shigeru, 1997. "Measuring and Comparing Business-Cycle Features," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 15(4), pages 432-44, October.
  5. Koop, Gary & Potter, Simon M., 1998. "Bayes factors and nonlinearity: Evidence from economic time series1," Journal of Econometrics, Elsevier, Elsevier, vol. 88(2), pages 251-281, November.
  6. John Geweke, 1999. "Using Simulation Methods for Bayesian Econometric Models," Computing in Economics and Finance 1999, Society for Computational Economics 832, Society for Computational Economics.
  7. Hansen, Bruce E, 1992. "The Likelihood Ratio Test under Nonstandard Conditions: Testing the Markov Switching Model of GNP," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 7(S), pages S61-82, Suppl. De.
  8. Olivier Blanchard & John Simon, 2001. "The Long and Large Decline in U.S. Output Volatility," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 32(1), pages 135-174.
  9. Albert, James H & Chib, Siddhartha, 1993. "Bayes Inference via Gibbs Sampling of Autoregressive Time Series Subject to Markov Mean and Variance Shifts," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 11(1), pages 1-15, January.
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Cited by:
  1. Sumru Altug & Melike Bildirici, 2010. "Business Cycles around the Globe: A Regime Switching Approach," Koç University-TUSIAD Economic Research Forum Working Papers, Koc University-TUSIAD Economic Research Forum 1009, Koc University-TUSIAD Economic Research Forum.
  2. Penelope A. Smith & Peter M. Summers, 2004. "Identification and normalization in Markov switching models of "business cycles"," Research Working Paper, Federal Reserve Bank of Kansas City RWP 04-09, Federal Reserve Bank of Kansas City.
  3. David Shepherd & Robert Dixon, 2008. "The Cyclical Dynamics and Volatility of Australian Output and Employment," The Economic Record, The Economic Society of Australia, The Economic Society of Australia, vol. 84(264), pages 34-49, 03.
  4. de Mello, Luiz & Moccero, Diego, 2011. "Monetary policy and macroeconomic stability in Latin America: The cases of Brazil, Chile, Colombia and Mexico," Journal of International Money and Finance, Elsevier, Elsevier, vol. 30(1), pages 229-245, February.
  5. Penelope A. Smith & Peter M. Summers, 2004. "How Well Do Markov Switching Models Describe Actual Business Cycles? The Case of Synchronization," Melbourne Institute Working Paper Series, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne wp2004n09, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne.
  6. William Martin & Robert Rowthorn, 2004. "Will Stability Last?," CESifo Working Paper Series 1324, CESifo Group Munich.
  7. Stephen G Cecchetti & Alfonso Flores-Lagunes & Stefan Krause, 2005. "Assessing the Sources of Changes in the Volatility of Real Growth," RBA Annual Conference Volume, in: Christopher Kent & David Norman (ed.), The Changing Nature of the Business Cycle Reserve Bank of Australia.
  8. Eric Mayer & Johann Scharler, 2010. "Noisy Information, Interest Rate Shocks and the Great Moderation," Economics working papers, Department of Economics, Johannes Kepler University Linz, Austria 2010-07, Department of Economics, Johannes Kepler University Linz, Austria.
  9. Lin, Justin Yifu & Fardoust, Shahrokh & Rosenblatt, David, 2012. "Reform of the international monetary system : a jagged history and uncertain prospects," Policy Research Working Paper Series 6070, The World Bank.
  10. Wenjuan Chen, 2011. "On the Continuation of the Great Moderation:New evidence from G7 Countries," SFB 649 Discussion Papers SFB649DP2011-060, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  11. Penelope A. Smith & Lei Lei Song, 2005. "Response of Consumption to Income, Credit and Interest Rate Changes in Australia," Melbourne Institute Working Paper Series, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne wp2005n20, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne.
  12. Balázs Égert & Rebeca Jiménez-Rodríguez & Evžen Kočenda & Amalia Morales-Zumaquero, 2006. "Structural changes in Central and Eastern European economies: breaking news or breaking the ice?," Economic Change and Restructuring, Springer, Springer, vol. 39(1), pages 85-103, June.
  13. Peter M. Summers, 2005. "What caused the Great Moderation? : some cross-country evidence," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 5-32.

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