Trend/Cycle decomposition

Abstract

Macro economists distinguish between the forces that cause long-term growth and those that cause temporary fluctuations such as recessions. The former include population growth, capital accumulation, and productivity change, and their effect on the economy is permanent. The latter are generally monetary shocks such as shifts in central bank policy that affect the real economy through price rigidities that cause output to deviate temporarily from its long-run path. This conceptual dichotomy motivates the decomposition of aggregate output, real GDP, into two components: the trend which accounts for long-term change, and the cycle which is a short-term deviation from trend. While economists no longer believe the ‘business cycle’ to be deterministically periodic, that terminology remains. Seasonal variation could be a third component, though it has been suppressed in ‘seasonally adjusted’ data such as GDP.