Business Cycle Facts Research Articles

Similarities yet Divergence in South Asian Macroeconomic Performance


 Stylized business cycle facts for South Asia are both similar and different from other regions. They show the dominance of supply shocks, often amplified by macroeconomic policies and procyclical current accounts. Interest and exchange rate volatility rose initially on liberalization, but fell as markets deepened. A gradual approach to openness and market development, with flexible exchange rates, that avoided complete liberalization, worked well initially. But a combination of excessive government/foreign borrowing and inadequate reserves made it difficult for smaller countries to withstand the multiple external shocks that began with the global pandemic. Domestic ability to smooth shocks and global safety nets are both essential. India benefitted from growing diversity, evolution to countercyclical macroeconomic policy better suited to structure and a good coordination of monetary and fiscal policies, with balance between demand stimulus and continuing supply-side reforms. Reserves and capital flow management policies helped insulate from global shocks. Intervention damped excess exchange rate volatility, reducing risk premiums.

AN ASSESSMENT ON THE MONETARY BUSINESS CYCLE THEORY

In recent years, considerable attention has given to analyzing the business cycle in terms of money. Many researchers have developed dynamic stochastic general equilibrium models that generate business cycle facts and guide for making monetary policy decisions. The aim of this study is to investigate how the persistence of total factor productivity (TFP) and money growth shocks drive the business cycles within an economy. To achieve this aim, we employ a monetary business cycle model with a cash-in-advance constraint, as in Cooley and Hansen (1995). Our results indicate that the volatility of macroeconomic variables is higher when the persistence of TFP shocks is greater compared to that of money growth shocks. Furthermore, TFP shocks seem to have a more significant role in driving variability within the models compared to money growth shocks. This is demonstrated by the higher percentage of variance decomposition attributed to TFP shocks, except in the case of consumption variability.

Financial contracting as behavior towards risk: The corporate finance of business cycles

This paper describes the balance sheet adjustments of debt and equity financed firms over time in an economy subject to taste shocks. A model is developed that describes a representative firm with a stochastic diminishing returns technology and a set of financial contracts that resolve a conflict-of-interest problem between differentially risk-averse bondholders and stockholders. The contractual resolution of this conflict-of-interest problem between the two agents is shown to shape certain stylized facts of business cycles ignored in Keynesian and Classical models. Changes in investor risk aversion and equity valuations trigger real investment decisions that can cause business cycles. Bond covenants then have the firm adjusting its financing decisions so as to offset any risk-shifting associated with the investment decisions. Stockholders manage the asset side of the firm’s balance sheet while bondholders (regulators in the case of banks) manage the financing side. In this way the welfare of both investors is coalesced over the business cycle. A similar type of analysis accounts for the age distribution of workers, and the size distribution of firms over the business cycle. Evidence presented here and elsewhere fails to reject these predictions for the U.S. non-financial and financial corporate sectors.

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

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.

Risk Premiums, Nominal Rigidities, and Limited Asset Market Participation

AbstractRecent developments in the asset pricing literature show that a combination of technology and distributive shocks can rationalize observed risk premia when firm ownership is concentrated in the hands of few households. We find that distributive shocks are unnecessary when nominal price rigidity is taken into account. Our results are driven by the income redistribution associated to procyclical variations in profit margins when firms ownership is concentrated, prices are sticky, and technology shocks hit the economy. In this regard, standard DSGE models that allow for firm ownership concentration have the potential to replicate both business cycle facts and the moments of financial variables.

What are the Driving Forces of Economic Downturn during COVID-19?

We investigate the main driving forces of business cycles and heterogeneity across industries during the COVID-19 crisis in Korea. We build a small open economy model, solved up to the second-order, to fit the stylized facts of business cycles and employ several structural shocks as candidates of driving forces. In contrast to the financial crisis in 2008, the transitory productivity shock is the predominant source, although the permanent productivity shock is assigned less importance during the pandemic. Negative preference shocks rapidly reduce consumption in 2020Q1 but bounce back with upward pressure on consumption growth in 2020Q2. The services sector, especially accommodation and food, is the most adversely affected by structural shocks at the onset of the COVID-19 outbreak.

A Contribution to the Corporate Finance of Business Cycles

This paper describes the balance sheet adjustments of debt and equity financed firms over the business cycle. A model is developed that describes a representative firm with a stochastic diminishing returns technology and a set of financial contracts that resolves a conflict of interest problem between differentially risk-averse bondholders and stockholders. The contractual resolution of this conflict of interest problem is shown to shape certain stylized facts of business cycles ignored in Keynesian and Classical models. Changes in the market value of equities trigger investment decisions and can cause business cycles. Bond covenants then have the firm adjusting its financing decisions so as to offset any risk-shifting associated with the investment decisions. Stockholders manage the asset side of the firm's balance sheet while bondholders (regulators in the case of banks) manage the financing side. In this way the welfare of both investors is coalesced over the business cycle. Evidence presented here and elsewhere fails to reject these predictions for the U.S. non-financial and financial corporate sectors.

Neo-Austrian Views of the Global Financial Crisis and Its Pre-Corona Aftermath

In the aftermath of the Global Financial Crisis (GFC) 2007/2008 the sales of Hayek’s (1944) Road to Serfdom quadrupled, a clear indication of renewed public interest in the views of (neo-) Austrian economists on macro-economic crises, especially financial crises. It is also true that several economists associated with the Austrian school, or those using neo-Austrian insights, correctly predicted the U.S. housing bubble and the subsequent GFC, apparently, a clear vindication of (neo-) Austrian cycle theory (Hunter, 2018). More surprising is that even relatively fierce opponents of neo-Austrian macro-theory have meanwhile begun to accept some Austrian insights. We thus ought to ask, what are the basic tenets of the Austrian Business Cycle Theory (ABCT) and how did it enable some economists to correctly predict the U.S. subprime crisis and its aftermath? In contrast, it is also true that mainstream macro-economists, although struggling heavily to come up with a suitable theoretical explanation of the GFC, neither accept the neo-Austrian explanation of crises, nor its policy implications. Therefore, we also need to ask why mainstream economists dismiss ABCT. Is it the alleged neo-Austrian bias towards the supremacy of an unfettered market economy which is rejected by the mainstream, or is it rather the lack of correspondence between ABCT and the stylized facts of business cycles, such as the positive correlation between consumption and investment? We also need to ascertain to what extent the basic Mises-Hayek cycle theory can be applied to an explanation of the U.S. subprime crisis and the GFC? For example, the neo-Austrian economist Salerno (2012: p. 41) has stated that the unprecedented monetary inventions by the U.S. Federal Reserve (Fed) and the enormous government deficits run by U.S. administrations since the Great Recession (GR) must at some point lead to a 1970s-style period of stagflation. Why has this failed to materialize? We have currently experienced the longest boom in the U.S. economy since the GR, a boom which has been engineered by anti-Austrian ultra-loose monetary policy. How do neo-Austrian authors manage to cope with such a fact? Such are the research questions dealt with in the following paper. Following an introduction to the main topic, the basic elements of ABCT are presented. Then, neo-Austrian extensions of basic ABCT are applied to an explanation of the U.S. housing bubble and the subsequent GFC. This is followed by discussion of radical neo-Austrian critiques of the unconventional monetary policies used to reflate the U.S. economy after the GR. The main question here is why such policies can continue without producing an economic downturn or bust. The paper concludes with a summary of neo-Austrian views on the GFC and its pre-Corona aftermath.

Endogenous business cycles with financial frictions

ABSTRACT This paper uncovers a series of belief shocks that drive the U.S. economy from both financial markets data and a financial accelerator model with self-fulfiling prophecies. Indeterminacy in the economy does not require externalities or increasing returns in production but it arises from an endogenous and countercyclical markup channel. The computed belief shocks are well identified and resemble the observable proxy in the real world. The model-driven solely by belief shocks performs well on replicating major U.S. business cycle facts. The belief-driven model contains a strong internal propagation mechanism and has more forecasting ability than a standard real business cycle model disturbed by technology shocks.

Business cycles and trends in Germany and Portugal: macroeconomic policy implications in the Euro Area

ABSTRACT We describe the neoclassical view of the business cycle by European Institutions in the Euro Area, and derive the stylized facts of business cycles and trends for Germany and Portugal in the period 1991–2018. The data are extracted from the European Commission’s AMECO database. To separate cycle and trend, we use the decomposition available in the AMECO database for the output, and the Hodrick-Prescott filter for the other variables. The results show that the amplitude of the business cycle and persistence of shocks are greater in Portugal than in Germany. They also show that the stylized facts of the business cycles of the two economies are quite different. Moreover, common shocks have asymmetric consequences. In the long run, there has been a convergence of inflation, general government structural balances, and real unit labour costs, but general government consolidated gross debt, fixed investment, and per capita potential GDP have been increasingly diverging, despite the behaviour of real wages and net exports in the two countries. Additionally, temporary shocks have permanent effects on the Portuguese economy. The results raise questions about the place-neutral macroeconomic policy enforced by the European institutions in the Euro Area, particularly in what concerns cohesion Member States.

Ambiguous business cycles: A quantitative assessment

In this paper, we examine the cyclical dynamics of a Real Business Cycle model with ambiguity averse consumers and investment irreversibility using the smooth ambiguity model of Klibanoff et al. (2005, 2009). Ambiguity of belief about the productivity process arises as agents do not know the process driving variation in aggregate TFP, and they must make inferences regarding the true process at the same time as they infer the behavior of the unobserved temporary component using a Kalman filtering algorithm. Our findings may be summarized as follows. First, the standard business cycle facts hold in our framework, which are not altered significantly by changes in the degree of ambiguity aversion. Second, we demonstrate a role for information and learning effects, and show that lower initial ambiguity or greater confidence coupled with learning dynamics lowers the volatility and increases the persistence in all of the key macroeconomic variables. Third, comparing the performance of our model to the New Keynesian business cycle model of Ilut and Schneider (2014) with maxmin expected utility, we find that the version of their model without nominal and real frictions turns out to have limited success at matching the moments for the quantity variables. In the maxmin expected utility framework, the worst case scenario instills too much caution on the part of agents who, in the absence of a key set of nominal and real frictions, end up excessively reducing their responses to TFP shocks.

On the Cyclical Properties of Hamilton’s Regression Filter

Hamilton (2017) criticises the Hodrick and Prescott (1981, 1997) filter (HP filter) because of three drawbacks (i. spurious cycles, ii. end-of-sample bias, iii. ad hoc assumptions regarding the smoothing parameter) and proposes a regression filter as an alternative. I demonstrate that Hamilton's regression filter shares some of these drawbacks. For instance, Hamilton's ad hoc formulation of a 2-year regression filter implies a cancellation of two-year cycles and an amplification of cycles longer than typical business cycles. This is at odds with stylised business cycle facts, such as the one-year duration of a typical recession, leading to inconsistencies, for example, with the NBER business cycle chronology. Nonetheless, I show that Hamilton's regression filter should be preferred to the HP filter for constructing a credit-to-GDP gap. The filter extracts the various medium-term frequencies more equally. Due to this property, a regression-filtered credit-to-GDP ratio indicates that imbalances prior to the global financial crisis started earlier than shown by the Basel III creditto-GDP gap.

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

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 HP1600 measures, and whether using the H84 predictor and other forecast extensions improves the HP filter’s properties at the ends of series. In general, H84 produces exaggerated volatilities and less credible trend movements during key economic periods so there is no material advantage in using H84 de-trending over HP1600. At the ends, the forecast-extended HP filter almost always performs better than the HP filter with no extension which performs slightly better than H84 forecast extension.

Imported inputs and the countercyclicality of net exports in emerging markets

This paper shows that the strong countercyclicality of net exports observed in emerging market economies can be explained to a large extent by the use of imported inputs in production. We build a single-sector small open economy business cycle model featuring imported inputs and variable capital utilization in production, and a working capital constraint. The model yields countercyclical net exports and realistic business cycle dynamics. The magnitude of the countercyclicality of net exports increases with the share of imported inputs. The elasticity of substitution between domestic and imported inputs is also critical in obtaining this result. The model also attributes an important role to import prices in matching the business cycle facts in emerging markets.

Labor Productivity, Effort and the Euro Area Business Cycle

The Euro Area is characterized by little variation in unemployment and strongly procyclical labor productivity. We capture both characteristics in a New Keynesian business cycle model with labor search frictions, where labor can vary along three margins: employment, hours, and effort. We estimate the model with Bayesian methods and find evidence for a significant use of the effort margin in generating procyclical productivity. We show that a model with labor effort is more successful at matching the business cycle facts than is one with variable capital utilization or dominant technology shocks. Finally, we demonstrate that effort dampens the response of inflation to exogenous shocks.

Structural Change and Business Cycles in Japan: Revisiting the Stylized Facts

The Japanese economy has experienced massive structural changes since the end of the 1990s, including a decline in the working-age population, a decade of deflation, an increase in the number of non-regular workers, which has almost doubled since the early 1990s, contributing to a large reduction in wage costs, and rapid advances in globalization. What are the implications of such changes for Japan’s business cycle dynamics? This study analyzes the stylized facts of Japanese business cycles under structural change. The results, based on traditional frequency domain analysis using more than 60 quarterly macroeconomic time series, provide robust findings. Among the most interesting ones is that scheduled hours worked play an increasingly important role as a buffer for labor input, suggesting that Japanese firms tend to adjust their labor input through hours worked, owing, in part, to the increasing number of non-regular workers, which allows firms to adjust labor input in a relatively flexible manner while keeping the number of employees unchanged. The increased role of hours worked is confirmed by an analysis based on a time-varying parameter structural vector autoregression (TVP-VAR) model taking the time-varying nature of the underlying structure of the economy into account. Meanwhile, in other areas such as private consumption and investment, wages, deflators and prices, and financial market indicators, the basic mechanism of business cycles appears to have remained largely unchanged, as reflected in the links between cyclical fluctuations in these series and cyclical fluctuations in output, implying that structural change may not necessarily affect the cyclical regularities in all macroeconomic time series.

What do deviation cycles measure? An analysis of the informational content of filter-based business cycles

Background: Empirical business cycle research typically commences with the extraction of a so-called deviation cycle using a time-series smoothing filter. This methodology is appealing for its pragmatism; it is easy to implement, and the output it produces is conveniently interpreted as percentage deviations from the natural level of output. However, recent literature offers staunch criticism of deviation cycle analysis, especially with regards to the assumption implicitly underlying it – that business cycle fluctuations are restricted to distinct intervals on the frequency domain.Aim: Despite its lack of a basis in theory, the analysis of deviation cycles over particular frequency ranges may still yield useful stylised business cycle facts. This, however, hinges on whether the information that a frequency filter captures consistently aligns with relevant theory-based business cycle concepts. Whether this is the case is an empirical matter, and herein lies the rationale for our research.Setting: We investigate the informational content of South Africa’s output deviation cycles.Methods: We extract deviation cycles at standard high- and medium-frequency ranges (denoted as short- and medium-term deviation cycles respectively) and analyse their informational overlap with the components of an alternative theory-based estimate of the business cycle, decomposed into demand, supply, domestic and foreign sources of business cycle dynamics.Results: Our findings suggest that the contents of deviation cycles extracted over a high-frequency range do not neatly correspond to the transitory ‘demand-driven’ business cycle, while cycles extracted over a medium-frequency range correspond closely to the combined path of permanent output shocks.Conclusion: One should thus be cautious of drawing strong conclusions about the nature of business cycles from filter-based deviation cycle estimates, particularly if the objective of the study relies on assuming that high-frequency deviation cycles correspond to transitory demand shocks.

Risk Premiums, Nominal Rigidities and Limited Asset Market Participation

Recent developments in the asset pricing literature show that a combination of technology and distributive shocks can rationalize observed risk premia when firm ownership is concentrated in the hands of few households. We find that distributive shocks are unnecessary when nominal price rigidity is taken into account. Our results are driven by the income redistribution associated to procyclical variations in profit margins when firms ownership is concentrated, prices are sticky and technology shocks hit the economy. In this regard, standard DSGE models that allow for firm ownership concentration have the potential to replicate both business cycle facts and the moments of financial variables.

On the Cyclical Properties of Hamilton's Regression Filter

Hamilton (2017) criticises the Hodrick and Prescott (1981, 1997) filter (HP filter) because of three drawbacks (i. spurious cycles, ii. end-of-sample bias, iii. ad hoc assumptions regarding the smoothing parameter) and proposes a regression filter as an alternative. I demonstrate that Hamilton's regression filter shares some of these drawbacks. For instance, Hamilton's ad hoc formulation of a 2-year regression filter implies a cancellation of two-year cycles and an amplification of cycles longer than typical business cycles. This is at odds with stylised business cycle facts, such as the one-year duration of a typical recession, leading to inconsistencies, for example, with the NBER business cycle chronology. Nonetheless, I show that Hamilton's regression filter should be preferred to the HP filter for constructing a credit-to-GDP gap. The filter extracts the various medium-term frequencies more equally. Due to this property, a regression-filtered credit-to-GDP ratio indicates that imbalances prior to the global financial crisis started earlier than shown by the Basel III creditto-GDP gap.

Sharing a ride on the commodities roller coaster: Common factors in business cycles of emerging economies

We explore the hypothesis that fluctuations in commodity prices are an important driver of business cycles in small emerging market economies (EMEs). First, we document that commodity prices exhibit strong comovement with other macro variables along the business cycle of these economies; and that a common factor accounts for most of the time series dynamics of these commodity prices. Guided by these stylized facts, we embed a commodity sector into a dynamic, stochastic, multi-country business cycle model of EMEs where exogenous fluctuations in commodity prices coexist with other driving forces. Commodity prices follow a common dynamic factor structure in the model. When estimated with EMEs data, the model gives to commodity shocks, mostly in the form of perturbations to their common factor, a paramount role when accounting for aggregate dynamics: more than a third of the variance of real output across the EMEs considered is associated to commodity price shocks. The model also performs well when accounting for other business cycle facts. A further amplification mechanism is a “spillover” effect from commodity prices to interest rates. Yet, sometimes, positive commodity price shocks have also cushioned other negative domestic shocks, particularly during the fast recovery from the world financial crisis.