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

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Author Info

  • James Morley

    (Washington University in St. Louis)

  • Charles Nelson

    (University of Washington)

  • Eric Zivot

    (University of Washington)

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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Bibliographic Info

Paper provided by University of Washington, Department of Economics in its series Working Papers with number UWEC-2002-01.

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Date of creation: Jan 2002
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Publication status: Published in Review of Economics and Statistics, Volume LXXXV, No. 2. May, 2003
Handle: RePEc:udb:wpaper:uwec-2002-01

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