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Band-pass filtering, cointegration, and business cycle analysis

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  • Luca Benati

Abstract

This paper critically assesses the practice of band-pass filtering (the non-structural, frequency-domain based decomposition of economic time series into trend and cyclical components), making two main points. First, it is shown that: (a) depending on the stochastic properties of the filtered process, the band-pass filtered cyclical component is entirely authentic, partly or mostly spurious, or even entirely spurious; and (b) as a simple consequence of the Lucas critique, the degree of authenticity of band-pass filtered cyclical components crucially depends on the monetary rule followed by the policy-maker. Second, taking a number of macroeconomic models as data-generation processes it is shown that band-pass filtering: (a) may markedly distort key business cycle stylised facts, as captured by the cross-correlations and the cross-spectral statistics between the cyclical components of the variables of interest and the cyclical component of GDP; and (b) may well create entirely spurious stylised facts. For example: both productivity and the money supply may appear procyclical even when they follow random walks by construction; the real wage may appear procyclical when in fact it is countercyclical; in general, the Phillips correlation between inflation and the cyclical component of economic activity will appear weaker than it is in reality. Again, the degree of authenticity of business cycle stylised facts uncovered via band-pass filtering crucially depends on the monetary rule followed by the policy-maker.

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  • Luca Benati, 2001. "Band-pass filtering, cointegration, and business cycle analysis," Bank of England working papers 142, Bank of England.
  • Handle: RePEc:boe:boeewp:142
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    9. Konstantakis, Konstantinos N. & Michaelides, Panayotis G., 2017. "Technology and Business Cycles: A Schumpeterian Investigation for the USA," MPRA Paper 80636, University Library of Munich, Germany.
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    16. Fidrmuc, Jarko & Ikeda, Taro & Iwatsubo, Kentaro, 2012. "International transmission of business cycles: Evidence from dynamic correlations," Economics Letters, Elsevier, vol. 114(3), pages 252-255.
    17. Mr. Martin Petri & Tahsin Saadi Sedik, 2006. "To Smooth or Not to Smooth—The Impact of Grants and Remittances on the Equilibrium Real Exchange Rate in Jordan," IMF Working Papers 2006/257, International Monetary Fund.
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