Business Cycle Facts Research Articles

Reconciling Conflicting Evidence on the Elasticity of Intertemporal Substitution: A Macroeconomic Perspective

This paper attempts to reconcile two opposing views about the elasticity of intertemporal substitution in consumption (EIS), a parameter that plays a key role in macroeconomic analysis. On the one hand, empirical studies using aggregate consumption data typically find that the EIS is close to zero (Hall, 1988). On the other hand, calibrated macroeconomic models designed to match growth and business cycle facts typically require that the EIS be close to one (Weil, 1989, Lucas, 1990, among others). We show that this apparent contradiction arises from ignoring two kinds of heterogeneity across individuals. First, a large fraction of households in the U.S. do not participate in stock markets. Second, a variety of microeconomic studies using individual-level data conclude that an individual's EIS increases with his wealth. We study a dynamic macroeconomic model featuring these two realistic sources of heterogeneity which have been largely assumed away in macroeconomics to date. We find that limited participation creates substantial wealth inequality matching that in U.S. data. Consequently, the properties of aggregate variables directly linked to wealth, such as investment and output, are almost entirely determined by the (high-elasticity) stockholders. At the same time, since consumption is much more evenly distributed across households than is wealth, estimation using aggregate consumption uncovers the low EIS of the majority of households (i.e., the poor). Moreover, this parsimonious model is also able to explain key cross-sectional facts of the U.S. data that have proved difficult to understand previously, suggesting that it can be a useful framework for studying a range of macroeconomic and policy questions.

Economic Growth and Business Cycles: A Critical Comment on Detrending Time Series

In this paper we pursue an approach based on economic theory to illustrate possible shortcomings of widely used detrending methods. We analyze a simple model of economic growth and business cycles in which investment and technical progress are stochastic. The Hodrick-Prescott and the Baxter-King filter are shown to detect spurious business cycles that are not related to actual cycles in the model. Our results cast doubts on the validity of commonly accepted stylized business cycle facts. We also discuss the relation of business cycle dating based on indicators of economic activity, as applied, for example, by the National Bureau of Economic Research, and the detrending results.

Empirical Evidence on the Austrian Business Cycle Theory

The Austrian business cycle theory suggests that a monetary shock disturbs relative prices, such as the term structure of interest rates, systematically altering profit rates across economic sectors. Resource use responds to those changes, generating a cyclical pattern of real income. The divergence of the interest rate structure, from the previous and unchanged time preferences, means that the expansion is unsustainable and must end in recession. Quarterly data for eight U.S. business cycles, 1950:1 through 1991:1 are standardized by time period and used to explore business cycle facts and relations between money, interest rates, capacity utilization and income. Results are consistent with the hypotheses of the Austrian theory of a business cycle caused by a monetary shock and propagated by relative price changes. The Austrian theory of the business cycle, as originally presented by Mises (1966, 1971) and Hayek (1967), implies several distinctive hypotheses about patterns of relative prices, the response of the income level and its composition, and the role of resource constraints. Business cycle theories demonstrate their power of explanation by hypothesis testing or by simulation in comparison to actual cycles. Since Burns and Mitchell (1946), "stylized facts" of cycles have become the behavior that needs to be explained. Austrian theory offers distinctive stylized facts about the cyclical behavior of real interest rates, changes in composition of capital structure, the relation of short-term to long-term interest rates, and the endogenous nature of expansion and contraction phases. Garrison (1986:449-450), Tullock (1988:74-76), and others have considered the empirical question of the explanatory power of the Austrian theory and whether the mechanism of price induced changes in the composition of the capital stock is sufficient in magnitude to account for the macroeconomic phenomenon of a business cycle. There is a clear need to consider how well the Austrian theory can explain observed cyclical behavior. There have been few empirical analyses of the Austrian theory, due to limited ability to express Austrian concepts in operational terms and to methodological opposition to empiri- cal testing of hypotheses. Mises (1966:56) claimed that "the impracticality of measurement is not due to the lack of technical methods for the establishment of measure. It is due to the absence of constant relations.... Statistical figures referring to economic events are his- torical data. They tell us what happened in a non-repeatable historical case." Within this methodology, empirical behavior could confirm or illustrate theory or characterize historical episodes, but would not be considered evidence in the evaluation of theory. The concepts of subjective economic behavior present widely recognized problems for measurement and

Seasonal cycles, business cycles, and monetary policy

This paper presents a dynamic general equilibrium model that is consistent with both seasonal and business cycle facts in the U.S. economy. The model features consumption durability and a transaction technology, both crucial in accounting for seasonal patterns of nominal variables. A calibrated version of the model is used to quantitatively evaluate welfare consequences of three alternative monetary policy rules: (1) the Fed's historical policy that smooths nominal interest rates at the seasonal frequency, but not at the business cycle frequency; (2) a constant-money-growth rule; and (3) a constant-interest-rate rule. We find that the historical policy is associated with higher welfare than both alternatives.

Detrending methods and stylized facts of business cycles in Norway - an international comparison

This paper analyses the stylized facts of business cycles in Norway, by comparing different detrending methods. As the choice of the appropriate data transformation depends on the nature of the underlying dynamic properties of the time series, a set of unit root tests are first applied to the data. The detrended data are analysed, both in the time domain and the frequency domain. The evidence suggests that whereas some variables (e.g. consumption and investment) behave consistently procyclically with GDP, for other variables (e.g. real wage and prices), the business cycle properties vary considerably with the detrending methods used. The results are evaluated from a real business cycle perspective, but overall, there is little evidence to support a (supply driven) real business cycle. Symmetries in business cycles are finally analysed by comparing the business cycles in Norway and selected countries.

What is the Real Story for Interest Rate Volatility?

Abstract What is the source of interest rate volatility? Why do low interest rates precede business cycle booms? Most observers tend to assume that monetary policy is largely responsible for it. Indeed, a standard real business cycle model delivers rather small fluctuations in real interest rates. Here, however, we present two models of the real business cycle variety, in which the fluctuations of real rates are of similar magnitude as in the data, while simultaneously matching salient business cycle facts. The second model also replicates the cyclical behavior of real interest rates. The models build on recent work by Danthine and Donaldson, Jermann, and Boldrin, Christiano and Fisher. We assume that there are workers and capital owners. The first model posits habit formation and adjustment costs to the stock of capital. The second model assumes that it takes time to plan investment and time to build capital.

Can Habit Formation Be Reconciled with Business Cycle Facts?

Many asset pricing puzzles can be explained when habit formation is added to standard preferences. We show that utility functions with a habit then gives rise to a puzzle of consumption volatility in place of the asset pricing puzzles when agents can choose consumption and labor optimally in response to more fundamental shocks. We show that the consumption reaction to technology shocks is too small by an order of magnitude when a utility includes a consumption habit. Moreover, once a habit in leisure is included, labor input is counterfactually smooth over the cycle. In the case of habits in both consumption and leisure, labor input is even countercyclical. Consumption continues to be too smooth. Journal of Economic Literature Classification Numbers: E13, E21, E32.

Economic Growth and Business Cycles: A Critical Comment on Detrending Time Series

In this paper we pursue an approach based on economic theory to illustrate possible shortcomings of widely-used detrending methods. We analyze a simple model of economic growth and business cycles in which investment and technical progress are stochastic. The Hodrick-Prescott and the Baxter-King filter are shown to detect spurious business cycles which are not related to actual cycles in the model. Our results cast doubts on the validity of commonly-accepted stylized business cycle facts. We also discuss the relation of business-cycle dating based on indicators of economic activity, as e.g. applied by the NBER, and the detrending results.

Real myths and a monetary fact

In their paper ‘Business cycles: real facts and a monetary myth,’ Kydland and Prescott (Federal Reserve Bank of Minneapolis Quarterly Review, 14, 1990) present a series of statistics, generated by using the Hodrick-Prescott filter, which they define as the ‘business cycle facts.’ Prescott (Federal Reserve Bank of Minneapolis Quarterly Review, 10, 1986) argued that the facts are immune to the method of detrending; however, even if we use the Hodrick-Prescott filter, we can get a set of facts that differ in important ways from those in Kydland and Prescott (1990). In particular, we can generate the conventional wisdom that real wages are acyclical, very different relative volatilities of consumption, investment and output, and M1 leading the cycle. In addition, we note that the other important fact generated by Kydland and Prescott, the countercyclicality of prices, was not actually a new result.

Endogenous Money Supply and the Business Cycle

This paper documents changes in the cyclical behavior of nominal data series that appear after 1979:Q3 when the Federal Reserve implemented a policy to lower the inflation rate. Such changes were not apparent in real variables. A business cycle model with impulses to technology and a role for money is used to show how alternative money supply rules are expected to affect observed business cycle facts. In this model, changes in the money supply rules have almost no effect on the cyclical behavior of real variables, yet have a significant impact on the cyclical nature of nominal variables. Journal of Economic LiteratureClassification Numbers: E32, E42, E50.

Can Market-Clearing Models Explain U.S. Labor Market Fluctuations?

Throughout the past two decades, market-clearing models of the business cycle have been praised for their ability to explain key empirical features of the post-war U.S. business cycle. Real business cycle (RBC) theory shows that in a model grounded in microeconomic foundations, disturbances to national productivity can explain how aggregate variables such as GDP, consumption and investment behave over time, relative to each other. One of the primary weaknesses of the standard RBC model, however, is its inability to account for some important aspects of U.S. labor market fluctuations. In this article, Victor E. Li summarizes important U.S. business cycle facts and examines how and why these market-clearing models have so much difficulty explaining the mannner in which these facts pertain to the labor market. Li then develops a simple market-clearing framework that demonstrates how a more realistic treatment of unemployment and incomplete risk-sharing may provide an alternative approach to better account for these labor market facts. In particular, Li looks at the situation where the risk of being unemployed cannot be completely shared across all individuals when there are unexpected aggregate economic shocks.

Detrending and business cycle facts

This paper examines the business cycle properties of a small set of a real US macroeconomic time series using a variety of detrending methods. It is shown that both quantitatively and qualitatively ‘stylized facts’ of US business cycles vary widely across detrending methods and that alternative detrending filters extract different types of information from the data. Implications and suggestions for current macroeconomic practice are provided.

Detrending and business cycle facts: A user’s guide

This note argues that it is hardly the case that the profession is fully aware that the application of different filters to the data leads to different outcomes and that we have enough evidence to claim that these differences are unimportant to evaluate the fit models to the data.

Detrending and business cycle facts: A comment

There is nothing misleading in the fact that different filtering techniques lead to different facts about macroeconomic time series. The fact that economists use a large number of filters to extract the ‘cyclical’ and ‘trend’ components of time series simply means that these concepts do not have unique meaning among them. Alternative filters provide different windows through which economists can examine their models and data. It is an open question as to whether some of these windows are more or less interesting to look through. The fact that some economists restrict themselves to a small set of filters is an issue to the extent that they thereby induce a lack of power. Here, I argue that a commonly used method of testing business cycle models induces no such lack of power.

A Skeptical Note on the Importance of Technology Shocks

This paper tests whether a real business cycle model can be built using a specific technological shock, a change in the depreciation rate, instead of an aggregate multiplicative shock. The model cannot duplicate standard business cycle facts.

Aggregate fluctuations in a monetary two-sector endogenous growth model

This paper examines the implications of a monetary human capital investment endogenous growth model for aggregate economic fluctuations. In addition, an exogenous growth model with a similar human capital investment specification is included in the analysis to compare the business cycle properties of the endogenous growth model with that of the exogenous growth model. The money introduced into the models allows for the liquidity effects. It is found that both the endogenous and exogenous human capital investment growth models are able to capture the business cycle properties of U.S. data closely. Some sensitivity analysis results are provided. The theory predicts that the stochastic properties of the human capital shocks affect the ability of the models to generate the business cycle facts.

Business Cycles Between Developed and Developing Economies

This paper compares the stylized facts of international real business cycles between developed and developing countries. A two‐sector two‐country real business cycles model is constructed to examine the cyclical behaviors of domestic as well as international macroeconomic variables, and to evaluate the model’s consistency with empirical observations. The model predicts correctly that consumption, investment, and saving are procyclical, while the trading balance/output ratio is countercyclical. There exist, however, some discrepancies between the model and the data.

Interpreting Saving-Investment Correlations

Feldstein and Horioka (1980) argued that the cross-sectional correlation of saving and investment provides a test of global capital mobility. We argue that the long-run correlation is determined by the intertemporal budget constraint, limited capital mobility and current account targeting. The short-run correlation reflects limited capital mobility and adjustment to supply and demand shocks. Our empirical analysis shows that the short-run correlation varies across countries and not over time, which suggests that it is a country-specific business cycle fact. The long-run correlation has substantially decreased over time, which suggests that limited capital mobility is partly responsible for its high value in the past.

Corporate Governance and Business Cycles in the G-7 Countries: Do Institutions Really Matter?

Research in corporate governance indicates that the relational framework within which firms make business decisions is very different across countries and these differences might be important in explaining differences in real economic phenomena such as growth rates in real output. On the other hand, research in business cycles indicates that many of the stylized facts of business cycles, themselves the result of business decisions that corporate governance presumably influences, are qualitatively similar. The objective of this paper is to see in what ways business cycles are similar and in what ways they are different across the G-7 countries, and whether any differences are related to differences in corporate governance and ownership structures. This research finds that business cycles across the G-7 countries tend to be more similar when comparing economic relationships from the product market where competition and the macroeconomic environment seem all important. On the other hand, business cycles are less similar across the G-7 countries when comparing certain financial relationships, and in certain cases these differences are related to differences in corporate governance and ownership structures.

AUSTRALIAN BUSINESS CYCLE FACTS*

This paper documents the post‐war business cycle facts for Australia. The Hodrick‐Prescott filter is used to remove the trend component from quarterly macroeconomic series. The business cycle facts we report are the volatilities of the cyclical (detrended) series and their cross correlations with cyclical real output. These facts are consistent with the business cycle facts reported for the United States, the United Kingdom and New Zealand with one exception. For most of the period since 1974, the real wage in Australia is strongly counter‐cyclical whereas for these countries it is procyclical.