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

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  • James C. Morley
  • Charles Nelson
  • Eric Zivot

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 decompositions. Furthermore, the zero correlation restriction can be rejected for U.S. quarterly GDP, with the estimated correlation being -0.9.

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Bibliographic Info

Paper provided by University of Washington, Department of Economics in its series Working Papers with number 0013.

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Date of creation: Apr 2000
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Handle: RePEc:udb:wpaper:0013

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  1. Kim, C-J & Nelson, C-R, 1997. "Friedman's Plucking Model of Business Fluctuations : Tests and Estimates of Permanent and Transitory Components," Discussion Papers in Economics at the University of Washington 97-06, Department of Economics at the University of Washington.
  2. 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, vol. 7(2), pages 151-174.
  3. Blanchard, Olivier Jean & Quah, Danny, 1989. "The Dynamic Effects of Aggregate Demand and Supply Disturbances," American Economic Review, American Economic Association, vol. 79(4), pages 655-73, September.
  4. Harvey, A C, 1985. "Trends and Cycles in Macroeconomic Time Series," Journal of Business & Economic Statistics, American Statistical Association, vol. 3(3), pages 216-27, June.
  5. Sichel, Daniel E, 1994. "Inventories and the Three Phases of the Business Cycle," Journal of Business & Economic Statistics, American Statistical Association, vol. 12(3), pages 269-77, July.
  6. Sichel, D.E., 1988. "Business Cycle Asymmetry: A Deeper Look," Papers 85, Princeton, Department of Economics - Financial Research Center.
  7. Beaudry, Paul & Koop, Gary, 1993. "Do recessions permanently change output?," Journal of Monetary Economics, Elsevier, vol. 31(2), pages 149-163, April.
  8. Clark, Peter K, 1987. "The Cyclical Component of U.S. Economic Activity," The Quarterly Journal of Economics, MIT Press, vol. 102(4), pages 797-814, November.
  9. Neftci, Salih N, 1984. "Are Economic Time Series Asymmetric over the Business Cycle?," Journal of Political Economy, University of Chicago Press, vol. 92(2), pages 307-28, April.
  10. Cochrane, John H, 1988. "How Big Is the Random Walk in GNP?," Journal of Political Economy, University of Chicago Press, vol. 96(5), pages 893-920, October.
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