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What's real about the business cycle?

  • James D. Hamilton

This paper argues that a linear statistical model with homoskedastic errors cannot capture the nineteenth-century notion of a recurring cyclical pattern in key economic aggregates. A simple nonlinear alternative is proposed and used to illustrate that the dynamic behavior of unemployment seems to change over the business cycle, with the unemployment rate rising more quickly than it falls. Furthermore, many but not all economic downturns are also accompanied by a dramatic change in the dynamic behavior of short-term interest rates. It is suggested that these nonlinearities are most naturally interpreted as resulting from short-run failures in the employment and credit markets and that understanding these short-run failures is the key to understanding the nature of the business cycle.

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Article provided by Federal Reserve Bank of St. Louis in its journal Review.

Volume (Year): (2005)
Issue (Month): Jul ()
Pages: 435-452

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Handle: RePEc:fip:fedlrv:y:2005:i:jul:p:435-452:n:v.87no.4
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  1. Granger, Clive W.J. & Machina, Mark J., 2006. "Structural attribution of observed volatility clustering," Journal of Econometrics, Elsevier, vol. 135(1-2), pages 15-29.
  2. Philip Rothman, . "Forecasting Asymmetric Unemployment Rates," Working Papers 9618, East Carolina University, Department of Economics.
  3. Garcia, Rene, 1998. "Asymptotic Null Distribution of the Likelihood Ratio Test in Markov Switching Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(3), pages 763-88, August.
  4. Hamilton, James D., 1987. "Monetary factors in the great depression," Journal of Monetary Economics, Elsevier, vol. 19(2), pages 145-169, March.
  5. van Dijk, Dick & Franses, Philip Hans & Paap, Richard, 2002. "A nonlinear long memory model, with an application to US unemployment," Journal of Econometrics, Elsevier, vol. 110(2), pages 135-165, October.
  6. Pablo A. Neumeyer & Fabrizio Perri, 2004. "Business Cycles in Emerging Economies: The Role of Interest Rates," NBER Working Papers 10387, National Bureau of Economic Research, Inc.
  7. Stock, James H, 1987. "Measuring Business Cycle Time," Journal of Political Economy, University of Chicago Press, vol. 95(6), pages 1240-61, December.
  8. James D. Hamilton, 1988. "Role Of The International Gold Standard In Propagating The Great Depression," Contemporary Economic Policy, Western Economic Association International, vol. 6(2), pages 67-89, 04.
  9. Marine Carrasco & Liang Hu, 2004. "Optimal test for Markov switching," 2004 Meeting Papers 374, Society for Economic Dynamics.
  10. J. Bradford De Long & Lawrence H. Summers, 1986. "Are Business Cycles Symmetric?," NBER Working Papers 1444, National Bureau of Economic Research, Inc.
  11. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  12. Arthur F. Burns & Wesley C. Mitchell, 1946. "Measuring Business Cycles," NBER Books, National Bureau of Economic Research, Inc, number burn46-1, September.
  13. Wesley Clair Mitchell, 1927. "Business Cycles: The Problem and Its Setting," NBER Books, National Bureau of Economic Research, Inc, number mitc27-1, September.
  14. Andrew Ang & Geert Bekaert, 1998. "Regime Switches in Interest Rates," NBER Working Papers 6508, National Bureau of Economic Research, Inc.
  15. Stock, James H., 1987. "Measuring Business Cycle Time," Scholarly Articles 3425950, Harvard University Department of Economics.
  16. Miron, Jeffrey A, 1986. "Financial Panics, the Seasonality of the Nominal Interest Rate, and theFounding of the Fed," American Economic Review, American Economic Association, vol. 76(1), pages 125-40, March.
  17. Hamilton, James D., 1996. "Specification testing in Markov-switching time-series models," Journal of Econometrics, Elsevier, vol. 70(1), pages 127-157, January.
  18. Brock, William A. & Mirman, Leonard J., 1972. "Optimal economic growth and uncertainty: The discounted case," Journal of Economic Theory, Elsevier, vol. 4(3), pages 479-513, June.
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