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Univariate vs. Multivariate Forecasts of GNP Growth and Stock Returns: Evidence and Implications for the Persistence of Shocks, Detrending Methods

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  • John H. Cochrane

Abstract

Lagged GNP growth rates are poor forecasts of future GNP growth rates in postwar US data, leading to the impression that GNP is nearly a random walk. However, other variables, and especially the lagged consumption/GNP ratio, do forecast long-horizon GNP growth, and show that GNP has temporary components. Labor income and stock prices (using the dividend/price ratio) display the same behavior. This paper documents these facts and examines their implications for the persistence of shocks to GNP and time-variation in expected stock returns. I find that GNP has an almost entirely transitory response to a GNP shock that holds consumption constant. This is intuitive: if consumption does not change, permanent income did not change, so the change in GNP should be transitory. Similarly, a stock price shock that holds dividends constant suggests a discount rate change, and prices display a large transitory movement in response to this shock. The paper also examines implications of transitory variations in GNP and labor income for methods of extracting stochastic trends or "cyclically adjusting" GNP, and for explaining "excess smoothness" violations of the permanent income hypothesis.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3427.

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Date of creation: Sep 1990
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Publication status: published as "Permanent and Transitory Components of GNP and Stock Prices," Quarterly Journal of Economics, pp. 241-265 (February 1994).
Handle: RePEc:nbr:nberwo:3427

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  1. Campbell, John & Deaton, Angus, 1989. "Why Is Consumption So Smooth?," Scholarly Articles 3221494, Harvard University Department of Economics.
  2. West, Kenneth D., 1988. "The insensitivity of consumption to news about income," Journal of Monetary Economics, Elsevier, Elsevier, vol. 21(1), pages 17-33, January.
  3. Beveridge, Stephen & Nelson, Charles R., 1981. "A new approach to decomposition of economic time series into permanent and transitory components with particular attention to measurement of the `business cycle'," Journal of Monetary Economics, Elsevier, Elsevier, vol. 7(2), pages 151-174.
  4. Hodrick, Robert J, 1992. "Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 5(3), pages 357-86.
  5. Campbell, John & Mankiw, Gregory, 1987. "Are Output Fluctuations Transitory?," Scholarly Articles 3122545, Harvard University Department of Economics.
  6. Robert G. King & Charles I. Plosser & James H. Stock & Mark W. Watson, 1987. "Stochastic Trends and Economic Fluctuations," NBER Working Papers 2229, National Bureau of Economic Research, Inc.
  7. Cochrane, John H, 1988. "How Big Is the Random Walk in GNP?," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 96(5), pages 893-920, October.
  8. Nelson, Charles R. & Plosser, Charles I., 1982. "Trends and random walks in macroeconmic time series : Some evidence and implications," Journal of Monetary Economics, Elsevier, Elsevier, vol. 10(2), pages 139-162.
  9. Cogley, T., 1989. "International Evidence On The Size Of The Random Walk In Output," Discussion Papers in Economics at the University of Washington, Department of Economics at the University of Washington 89-02, Department of Economics at the University of Washington.
  10. Fama, Eugene F & French, Kenneth R, 1988. "Permanent and Temporary Components of Stock Prices," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 96(2), pages 246-73, April.
  11. Clark, Peter K, 1987. "The Cyclical Component of U.S. Economic Activity," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 102(4), pages 797-814, November.
  12. Cochrane, John H. & Sbordone, Argia M., 1988. "Multivariate estimates of the permanent components of GNP and stock prices," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 12(2-3), pages 255-296.
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Cited by:
  1. Zinzhu Chen & Prakash Kannan & Prakash Loungani & Bharat Trehan, 2011. "New evidence on cyclical and structural sources of unemployment," Working Paper Series, Federal Reserve Bank of San Francisco 2011-17, Federal Reserve Bank of San Francisco.
  2. Clarida, Richard & Gali, Jordi, 1994. "Sources of real exchange-rate fluctuations: How important are nominal shocks?," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 41(1), pages 1-56, December.
  3. Dean Corbea & Sam Ouliaris & Peter C.B. Phillips, 1991. "A Reexamination of the Consumption Function Using Frequency Domain Regressors," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 997, Cowles Foundation for Research in Economics, Yale University.
  4. Bharat Trehan, 1991. "Using consumption to forecast income," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue jun7.
  5. Robert F. Engle & Joao Victor Issler, 1993. "Estimating Sectoral Cycles Using Cointegration and Common Features," NBER Working Papers 4529, National Bureau of Economic Research, Inc.
  6. Hugo Oliveros & Carlos Huertas, . "Desequilibrios Nominales y Reales del Tipo de Cambio en Colombia," Borradores de Economia 220, Banco de la Republica de Colombia.
  7. Norman Morin, 2006. "Likelihood ratio tests on cointegrating vectors, disequilibrium adjustment vectors, and their orthogonal complements," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2006-21, Board of Governors of the Federal Reserve System (U.S.).
  8. Jaimovich, Nir & Floetotto, Max, 2008. "Firm dynamics, markup variations, and the business cycle," Journal of Monetary Economics, Elsevier, Elsevier, vol. 55(7), pages 1238-1252, October.
  9. Ramey, Valerie A., 1992. "The source of fluctuations in money : Evidence from trade credit," Journal of Monetary Economics, Elsevier, Elsevier, vol. 30(2), pages 171-193, November.

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