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The importance of nonlinearity in reproducing business cycle features

  • James Morley
  • Jeremy M. Piger

This paper considers the ability of simulated data from linear and nonlinear time-series models to reproduce features in U.S. real GDP data related to business cycle phases. We focus our analysis on a number of linear ARIMA models and nonlinear Markov-switching models. To determine the timing of business cycle phases for the simulated data, we present a model-free algorithm that is more successful than previous methods at matching NBER dates and associated features in the postwar data. We find that both linear and Markov-switching models are able to reproduce business cycle features such as the average growth rate in recessions, the average length of recessions, and the total number of recessions. However, we find that Markov-switching models are better than linear models at reproducing the variability of growth rates in different business cycle phases. Furthermore, certain Markov-switching specifications are able to reproduce high-growth recoveries following recessions and a strong correlation between the severity of a recession and the strength of the subsequent recovery. Thus, we conclude that nonlinearity is important in reproducing business cycle features.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2004-032.

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Date of creation: 2005
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Publication status: Published in Nonlinear Time Series Analysis of Business Cycles, edited by C. Milas, P. Rothman, and D. van Dijk. Elsevier Science, Amsterdam, 2006
Handle: RePEc:fip:fedlwp:2004-032
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