Business Cycle Facts Research Articles

Evaluating growth cycle synchronisation in the EU

This paper provides an insight into the level of economic and monetary integration in Europe by analysing the degree of growth cycle synchronisation between seven European countries over the past thirty years. Two univariate trend-cycle decomposition methodologies, the Beveridge–Nelson (BN) decomposition and Harvey and Trimbur [Harvey, A.C. & Trimbur, T.M. (2003) “General Model-Based Filters for Extracting Cycles and Trends in Economic Time Series”, The Review of Economics and Statistics, 85(2), 244–255.]'s unobserved component model, together with a multivariate extension of the BN decomposition incorporating trend and cycle restrictions, are used to identify the trend and cyclical components from real GDP for each of the seven countries. The cycles extracted from the two univariate approaches vary significantly in both cycle period and amplitude. The average correlation calculated from the BN cycles are also smaller than the corresponding correlation estimated using cycles extracted from the unobserved component model. This confirms the argument in Canova [Canova, F. (1998) “Detrending and Business Cycle Facts”, Journal of Monetary Economics, 41(3), 475–512.] that the use of different trend-cycle decomposition methodologies may influence the results obtained. The results produced from the multivariate model indicate the presence of common features in the data. This may reflect the coordinated and common monetary and fiscal policies that these countries have shared over the sample period. However, the finding of codependent and heterogeneous growth cycles raises concerns about the operation of the European Monetary Union (EMU), as it implies that members may face significant stabilisation costs.

The brevity and violence of contractions and expansions

Early studies of business cycles argued that contractions in economic activity were briefer (shorter) and more violent (rapid) than expansions. This paper systematically investigates this claim and in the process discovers a robust new business cycle fact: contractions in employment are briefer and more violent than expansions but we cannot reject the null of equal brevity and violence for expansions and contractions in output. The difference arises because employment typically lags output around peaks but they coincide in their troughs. We discuss the performance of existing business cycle models in accounting for this fact, and conclude that none can fully account for it. We then show that a business cycle model with asymmetric adjustment costs on employment and a choice of when to scrap old technologies can account for the business cycle fact both qualitatively and quantitatively.

Skill Specific Unemployment with Imperfect Substitution of Skills

A large body of literature explains the inferior position of unskilled workers by imposing a structural shift in the labor force skill composition. This paper takes a different approach by emphasizing the connection between cyclical variations in skilled and unskilled labor markets. Using a stylized business cycle model with search frictions in the respective sub-markets, I find that imperfect substitution between skilled and unskilled labor creates a channel for the variations in the sub-markets. Together with a general labor augment- ing technology shock, it can generate downward sloping Beveridge curves. Calibrating the model to US data yields higher volatilities in the unskilled labor markets and reproduces stylized business cycle facts.

Business Cycle and Asset Prices: A Computable General Equilibrium Analysis with Agency Costs and Habit Formation

For the purpose of explaining both business cycles and asset returns, we examine a real business cycle (RBC) model with habit-augmented preferences and endogenous costs of adjusting the capital stock. Following the agency-cost model of Carlstrom and Fuerst (1997), capital adjustment costs are affected by the level of entrepreneur's net worth such that an increase in net worth (following a positive productivity shock) lowers agency costs associated with external financing, and hence makes it easier to expand the capital stock. Along with the restricted labor supply, the model resolves the asset pricing puzzles of the consumption-based model in the sense that the implied stochastic discount factor (or pricing kernel) reaches the Hansen-Jagannathan (1991) volatility bound. Further, this improvement in the asset pricing dimension is achieved without reducing its business cycle performance such as output and consumption volatility. This is in a sharp contrast to the standard RBC model with the reduced-form adjustment cost technology where sufficiently low supply elasticity of capital (or persistently high capital adjustment costs) is required to generate the equity premium at the expense of low output volatility. Here, the capital supply is highly elastic under the plausible calibrations of the structural parameters affecting endogenous capital adjustment costs. The slugghish behavior of net worth, as a shifter of the capital supply curve, is the key mechanism by which capital adjustment is delayed, hampering consumption smoothing desired by households with habit persistence preferences. The agency-costs model reveals that a small curvature in the capital adjustment cost function, viewed as crucial for understanding the fluctuations in Tobin's q, can be also consistent with both the historical equity premium and the key business cycle facts.

Financial frictions, capital reallocation, and aggregate fluctuations

We address an important business cycle fact, i.e., the amplified and hump-shaped responses of output to productivity shocks, in a dynamic general equilibrium model with financial frictions. Models with financial frictions in the current literature have either the amplification mechanism or the propagation mechanism. Our model shows that the dynamic interaction of borrowing constraints, endogenous capital accumulation, and capital reallocation among agents with different productivity constitutes a mechanism through which the effects of productivity shock on aggregate output are amplified and propagated, more in line with the empirical evidence than other related models in the literature.

Dynamic Stochastic General Equilibrium Models as a Tool for Policy Analysis

This article discusses the evolution of dynamic macroeconomic models from calibrated Real Business Cycle models to estimated dynamic stochastic general equilibrium models. The purpose is to suggest the usefulness of these models as a tool for policy analysis, with a particular emphasis on aspects of monetary policy. (JEL classification: D58, E50) This article gives an overview of the literature that has led to the emergence of dynamic stochastic general equilibrium (DSGE) models. This approach to macroeconomic modelling has gained widespread support among researchers and has recently started to be taken seriously by policy-making institutions as a modelling framework which is useful for policy analysis and the conceptual support of decision making. Modern macroeconomics is the result of an intense, and at times passionate, scientific debate that has taken place over the last decades. In the early 1980s, a new approach to the business cycle analysis was introduced by Kydland and Prescott (1982). The main tenet of their approach was that a small model of a frictionless and perfectly competitive market economy, inhabited by utility-maximising rational agents which operate subject to budget constraints and technological restrictions, could replicate a number of stylised business cycle facts when hit by random productivity shocks. This so-called real business cycle (RBC) approach to macroeconomic modelling was early on criticised on various aspects. Nevertheless, as it is now widely acknowledged, the RBC agenda has made a lasting methodological contribution. Most of today’s DSGE models

Finance and international business cycles

Business cycles are more correlated among countries that have similar financial structures. We first document this empirical regularity using OECD data, and then build a two-country DSGE model with financial frictions that replicates it. Alternative monetary policy regimes and parameter values are explored. Output co-movements increase when the countries involved are linked by a credible exchange rate peg and when they open up to trade; they decrease when their financial openness increases. The model also accounts for a number of stylized facts of international business cycles, such as the positive international correlation of output, investment and employment.

Technological Innovations and the Interest Rate

We build a dynamic general equilibrium model that adds a banking sector to the standard RBC model. We look at the response of the real interest rate to innovations in the banks' technology and in the nonbank firms' technology. While technological innovations in the nonbanking sector put upward pressure on the interest rate, technological innovations in banks exert downward pressure on the interest rate. This implies that, if the technological innovations in banks are strong enough, stochastic simulation experiments generate negative correlations between the real interest rate and current and future values of real output. This is especially significant because negative correlations between the interest rate and output are a key post-war U.S. business cycle fact difficult to replicate in benchmark dynamic models.

LIQUIDITY CONSTRAINTS, HETEROGENEOUS HOUSEHOLDS AND SUNSPOT FLUCTUATIONS

This paper is concerned with the empirical relevance of indeterminacy and sunspots in explaining the business cycle. It argues that financial constraints provide a propagation mechanism able to generate business cycle facts observed in data in response to sunspot shocks. This point is demonstrated using an equilibrium business cycle model featuring heterogeneous households, endogenous labor supply and liquidity constraints. We first show that the model exhibits indeterminacy for roughly constant returns to scale. We then establish that our model accounts for stylized facts that neither the standard RBC model nor previous sunspots models have been able to capture. More specifically, the model driven purely by sunspots matches the procyclical movements in aggregate consumption, and the positively correlated forecastable changes of basic macroeconomic variables.

BUSINESS-CYCLE FILTERING OF MACROECONOMIC DATA VIA A LATENT BUSINESS-CYCLE INDEX

We use Markov chain Monte Carlo methods to augment, via a novel multimove sampling scheme, a vector autoregressive (VAR) system with a latent business-cycle index that is negative during recessions and positive during expansions. We then sample counterfactual values of the macroeconomic variables in the case where the latent business-cycle index is held constant. These counterfactual values represent posterior beliefs about how the economy would have evolved absent business-cycle fluctuations. One advantage is that a VAR framework provides model-consistent counterfactual values in the same way that VARs provide model-consistent forecasts, so data series are not filtered in isolation from each other. We apply these methods to estimate the business-cycle components of industrial production, consumer price inflation, the federal funds rate, and the spread between long-term and short-term interest rates. These decompositions provide an explicitly counterfactual approach to isolating the effects of the business cycle and to deriving empirical business-cycle facts.

U.S. Labor Market Dynamics Revisited

The picture of U.S. labour market dynamics is opaque. Empirical studies have yielded contradictory findings and debates have emerged regarding their implications. This paper aims at clarifying the picture, which is important for the understanding of the operation of the labour market, for the study of business cycles, for the explanation of wage behaviour, and for the formulation of policy. The paper determines what facts can be established, what are their implications, and what remains to be further investigated. The main contributions made here are: (i) Listing of data facts that can be agreed upon. These indicate that there is considerable cyclicality and volatility of both accessions to employment and separations from it. Hence, both are important for the understanding of the business cycle. (ii) Presenting the business cycle facts of key series. (iii) Pointing to specific gaps in the data picture: disparities in the measurement of the sizeable flows between employment and the pool of workers out of the labour force, disagreements about the relative volatility of job finding and separation rates across data sets, and the fact that the fit of the gross flows data with net employment growth data differs across studies and is not high. The definite characterization of labour market dynamics depends upon the closing of these data gaps.

Liquidity, infinite horizons and macroeconomic fluctuations

This paper develops a computable dynamic general equilibrium model in which corporate demand for liquidity is endogenously determined. In the model, liquidity demand is motivated by moral hazard, as in Holmström and Tirole (J. Politic. Econom. 106 (1998) 1). As a result of incorporating agency cost and endogenously determined liquidity demand, the model can replicate an empirical business cycle fact, the hump-shaped dynamic response of output, which is seldom observed in standard RBC dynamics. Further, in the model the corporate demand for liquidity from a financial intermediary (credit line, for instance) is pro-cyclical, while the degree of liquidity dependence (defined as liquidity demand divided by corporate investment) is counter-cyclical. These business cycle patterns are consistent with a stylized fact empirically verified in the lending view literature.

Asset returns and business cycles in models with investment adjustment costs

We show that adjustment cost models with labor supply can explain both asset returns and business cycle facts when adjustment costs penalize the changes of investment. This conclusion stands in contrast to results obtained in the literature with adjustment costs that penalize the changes of capital.

International business cycles: What are the facts?

Modern business cycle theory involves developing models that explain stylized facts. For this strategy to be successful, these facts should be well established. In this paper, we focus on the stylized facts of international business cycles. We use the generalized method of moments and quarterly data from twenty industrialized countries to estimate and test hypotheses concerning pairwise cross-country correlations of macroeconomic aggregates. A remarkable common feature emerges: these correlations are mostly positive, not very high and of a similar order of magnitude. The most important discrepancy with the theory is the low cross-country correlation of consumption.

Labor hoarding, superior information, and business cycle dynamics

In this paper, we test whether a labor-hoarding environment with basic and augmented laws of motion provide an adequate explanation for observed business cycle dynamics. The basic law of motion assumes that the information set used by economic agents to forecast future forcing variables includes only the history of forcing variables. Augmented laws of motion assume that the information set is superior and include both forcing and hidden exogenous variables. We show that the labor-hoarding environment with the basic law of motion fails to replicate observed business cycle facts, while the environment with augmented laws of motion successfully matches these facts.

Is growth useful in RBC models?

Most RBC models need deterministic technical progress to account for the business cycle stylized facts. Does this mean that we are to dismiss the evidence in favor of a unit root in output when we have a prior in favor of RBC models? To answer this question, we explore the usefulness of introducing an endogenous source of growth in a standard RBC model. Using a formal measure of fit, we show that doing so permits us both to reproduce some key business cycle facts and to obtain a unit root in output.

Can the labor market search model explain the fluctuations of allocations of time?

We examine whether the labor market search model can account for the business cycle facts on the three uses of time: employment, unemployment and non-participation. The standard search model is modified by making endogenous the time allocation decision between market and non-market activities. Despite its good performance on the employment rate, this framework fails to mimic the empirical dynamics on the two other uses of time, notably the strongly countercyclical behavior of the unemployment rate. This conclusion is shown to be robust to the specification of households’ preferences.

What is the Real Story for Interest Rate Volatility?

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 real rate fluctuations 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-Donaldson, Jermann, and Boldrin-Christiano-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.

Business Cycles in Developing Countries: Are They Different?

This paper demonstrates that developing countries differ considerably from their developed counterparts when focus is on the nature and characteristics of short-run macroeconomic fluctuations. Cycles are generally shorter, and the stylized facts of business cycles across countries are more diverse than those of the rather uniform industrialized countries. Supply-side models are generally superior in explaining changes in output, but a “one-size fits all” approach in formulating policy is inappropriate. Our results also illustrate the critical importance of understanding business regularities as a stepping-stone in the process of designing appropriate stabilization policy and macroeconomic management in developing countries.

Monetary Policy in a World with Different Financial Systems

Major currency areas are characterized by important differences in financial structure that are clear in microeconomic data. Surprisingly, this fact is seldom discussed in the analysis of the international transmission of shocks. This paper attempts to fill this gap. First, I examine some stylized facts about financial diversity and cyclical correlations among OECD countries. Data show a negative relation between cyclical correlations and differences in financial systems. Second, using a two-country model with sticky prices, imperfect financial integration and borrowing constraints on investment, calibrated to US and euro area data, I analyze the international transmission of shocks with different degrees of financial fragility in the two economies. I find, first, that financial diversity can account for heterogenous business cycle fluctuations and reproduce the negative relation found in the data. Differential responses to shocks are shown to occur with independent monetary policies - Taylor rules or rigid inflation targets -. The result is robust under different degrees of economic and financial openness and of correlation of underlying shocks. Credible pegs help to increase synchronization of cycles. The model is successful in accounting for some international business cycle facts, like the output correlations puzzle.