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Univariate vs. Multivariate Forecasts of GNP Growth and Stock Returns: Evidence and Implications for the Persistence of Shocks, Detrending Methods

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  • John H. Cochrane

Abstract

Lagged GNP growth rates are poor forecasts of future GNP growth rates in postwar US data, leading to the impression that GNP is nearly a random walk. However, other variables, and especially the lagged consumption/GNP ratio, do forecast long-horizon GNP growth, and show that GNP has temporary components. Labor income and stock prices (using the dividend/price ratio) display the same behavior. This paper documents these facts and examines their implications for the persistence of shocks to GNP and time-variation in expected stock returns. I find that GNP has an almost entirely transitory response to a GNP shock that holds consumption constant. This is intuitive: if consumption does not change, permanent income did not change, so the change in GNP should be transitory. Similarly, a stock price shock that holds dividends constant suggests a discount rate change, and prices display a large transitory movement in response to this shock. The paper also examines implications of transitory variations in GNP and labor income for methods of extracting stochastic trends or "cyclically adjusting" GNP, and for explaining "excess smoothness" violations of the permanent income hypothesis.

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  • John H. Cochrane, 1990. "Univariate vs. Multivariate Forecasts of GNP Growth and Stock Returns: Evidence and Implications for the Persistence of Shocks, Detrending Methods," NBER Working Papers 3427, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:3427
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    Cited by:

    1. Robert F. Engle & Joao Victor Issler, 1993. "Estimating Sectoral Cycles Using Cointegration and Common Features," NBER Working Papers 4529, National Bureau of Economic Research, Inc.
    2. Jinzhu Chen & Prakash Kannan & Prakash Loungani & Bharat Trehan, 2012. "New evidence on cyclical and structural sources of unemployment," Proceedings, Federal Reserve Bank of San Francisco, issue March, pages 1-23.
    3. Corbae, Dean & Ouliaris, Sam & Phillips, Peter C B, 1994. "A Reexamination of the Consumption Function Using Frequency Domain Regressions," Empirical Economics, Springer, vol. 19(4), pages 595-609.
    4. Ramey, Valerie A., 1992. "The source of fluctuations in money : Evidence from trade credit," Journal of Monetary Economics, Elsevier, vol. 30(2), pages 171-193, November.
    5. Clarida, Richard & Gali, Jordi, 1994. "Sources of real exchange-rate fluctuations: How important are nominal shocks?," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 41(1), pages 1-56, December.
    6. Jaimovich, Nir & Floetotto, Max, 2008. "Firm dynamics, markup variations, and the business cycle," Journal of Monetary Economics, Elsevier, vol. 55(7), pages 1238-1252, October.
    7. Bharat Trehan, 1991. "Using consumption to forecast income," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue jun7.
    8. Hugo Oliveros & Carlos Huertas, 2002. "Desequilibrios Nominales y Reales del Tipo de Cambio en Colombia," Borradores de Economia 220, Banco de la Republica de Colombia.
    9. Norman J. Morin, 2006. "Likelihood ratio tests on cointegrating vectors, disequilibrium adjustment vectors, and their orthogonal complements," Finance and Economics Discussion Series 2006-21, Board of Governors of the Federal Reserve System (U.S.).

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