Does Hamilton’s OLS Regression Provide a “better alternative” to the Hodrick-Prescott Filter? A New Zealand Business Cycle Perspective

Abstract

Within a New Zealand business cycle context, we assess whether Hamilton’s (H84) OLS regression methodology produces stylised business cycle facts which are materially different from the Hodrick–Prescott (HP) and Baxter–King (BK) measures, and whether using the H84 predictor for forecast-extension improves the HP filter’s properties at the ends of series. Stylised business cycle facts were computed for a set of key New Zealand macroeconomic variables. In general, H84 produces greater volatilities and less credible trend movements during key economic periods than either HP or BK, and so for this purpose there is no material advantage in using H84 over HP or BK. At the ends of series, we evaluate the performance of the forecast-extended HP filter for three representative business cycle environments. The forecast-extension methods compared include the H84 predictor, the informed forecasts of three leading New Zealand economic agencies, two methods based on models of past data, and the HP filter with no extension. As expected, the better the forecast-extension the more accurate the HP filter at the ends of series and, as reported elsewhere in the literature, the HP filter with no extension performed poorly. However, in all cases considered the H84 predictor performed worst.