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Why Are the Beveridge-Nelson and Unobserved-Components Decompositions of GDP So Different?

James Morley1; Charles R. Nelson2; Eric Zivot2

1 Washington University in St. Louis · 2 University of Washington

The Review of Economics and Statistics 2003

This paper reconciles two widely used decompositions of GDP into trend and cycle that yield starkly different results. The Beveridge-Nelson (BN) decomposition implies that a stochastic trend accounts for most of the variation in output, whereas the unobserved-components (UC) implies cyclical variation is dominant. Which is correct has broad implications for the relative importance of real versus nominal shocks. We show the difference arises from the restriction imposed in UC that trend and cycle innovations are uncorrelated. When this restriction is relaxed, the UC decomposition is identical to the BN decomposition. Furthermore, the zero-correlation restriction can be rejected for U.S. quarterly GDP, with the estimated correlation being -0.9.

DOI
10.1162/003465303765299765
Volume
85 (2)
Pages
235-243
Language
en
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