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The Relative Importance of Permanent and Transitory Components: Identification and Some Theoretical Bounds

  • Danny Quah

Much macroeconometric discussion has recently emphasised the economic significance of the size of the permanent component in GNP. Consequently, a large literature has developed that tries to estimate this magnitude - measured, essentially, as the spectral density of increments in GNP at frequency zero. This paper shows that unless the permanent component is a random walk this attention has been misplaced: in general, that quantity does not identify the magnitude of the permanent component. Further, by developing bounds on reasonable measures of this magnitude, the paper shows that a random walk specification is biased towards establishing the permanent component as important.

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File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmg_pdfs/dp126.pdf
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Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp126.

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Date of creation: Oct 1991
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Handle: RePEc:fmg:fmgdps:dp126
Contact details of provider: Web page: http://www.lse.ac.uk/fmg/

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  1. 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.
  2. Nelson, Charles R. & Plosser, Charles I., 1982. "Trends and random walks in macroeconmic time series : Some evidence and implications," Journal of Monetary Economics, Elsevier, vol. 10(2), pages 139-162.
  3. Perron, Pierre, 1989. "The Great Crash, the Oil Price Shock, and the Unit Root Hypothesis," Econometrica, Econometric Society, vol. 57(6), pages 1361-1401, November.
  4. 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.
  5. Olivier Jean Blanchard & Danny Quah, 1988. "The Dynamic Effects of Aggregate Demand and Supply Disturbance," Working papers 497, Massachusetts Institute of Technology (MIT), Department of Economics.
  6. Clark, Peter K., 1988. "Nearly redundant parameters and measures of persistence in economic time series," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 447-461.
  7. Campbell, John & Mankiw, Gregory, 1987. "Are Output Fluctuations Transitory?," Scholarly Articles 3122545, Harvard University Department of Economics.
  8. West, Kenneth D, 1988. "On the Interpretation of Near Random-walk Behavior in GNP," American Economic Review, American Economic Association, vol. 78(1), pages 202-09, March.
  9. Quah, D., 1989. "Permanent And Transitory Movements In Labor Income: An Explanation For "Excess Smoothness" In Consumption," Working papers 535, Massachusetts Institute of Technology (MIT), Department of Economics.
  10. Christiano, Lawrence J. & Eichenbaum, Martin, 1990. "Unit roots in real GNP: Do we know, and do we care?," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 32(1), pages 7-61, January.
  11. Watson, Mark W., 1986. "Univariate detrending methods with stochastic trends," Journal of Monetary Economics, Elsevier, vol. 18(1), pages 49-75, July.
  12. Marco Lippi & Lucrezia Reichlin, 1993. "The dynamic effects of aggregate demand and supply disturbances: comment," ULB Institutional Repository 2013/10159, ULB -- Universite Libre de Bruxelles.
  13. Matthew D. Shapiro & Mark W. Watson, 1988. "Sources of Business Cycle Fluctuations," NBER Working Papers 2589, National Bureau of Economic Research, Inc.
  14. Townsend, Robert M, 1983. "Forecasting the Forecasts of Others," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 546-88, August.
  15. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
  16. Francis X. Diebold & Glenn D. Rudebusch, 1988. "Long memory and persistence in aggregate output," Finance and Economics Discussion Series 7, Board of Governors of the Federal Reserve System (U.S.).
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