No full-text available
To read the full-text of this research,
you can request a copy directly from the authors.
What causes business cycles to elongate, or recessions to intensify?
Abstract
In this paper we use both New Keynesian and Classical monetary models to explain why volatility transfers from high to low frequency cycles occur, causing the business cycle to elongate, and how they could reverse. Our results show that an increase in inflation aversion or a reduction in the commitment to output stabilization would create volatility transfers sufficient to give rise to a great moderation, while a reversal of those commitments would take it away again. In short, the lower frequency cycles become more volatile at the expense of traditional business cycle frequencies, even though there are no reversals in the parameters that govern the economy’s underlying economic behaviour, dynamics or volatility. This implies we should expect less frequent but more severe recessions, with smoother business cycle expansion phases in between. We identify moderate expectations for output or earnings growth to be the key element that under-pins these results.
... The concerted action of governments, banks and international free trade associations such as the European Union (and EFTA), NAFTA (Canada, US, Mexico), Asian unions (ASEAN, AFTA and RCEP), BRICS (China, Russia, Brazil, India, South Africa) has led to a lengthening of the business cycle while limiting the timing and impact of downturns (there are no longer deep crises such as those in the US in the 1930s or in the UK in the 1920s and 1940s). A study by Crowley and Hallett [4] suggests that the "Great Moderation" may have been caused by a shift in cyclical volatility away from shorter cycles of economic growth due to structural changes in the economy. The National Bureau of Economic Research [5] also confirms that the duration of business cycles has become longer, in line with the fact that expansions have become longer and contractions shorter. ...
This article explores the dynamic interplay between the business cycle and the housing market in Poland from 2007 to 2022. It examines the complex relationship between economic cycles and the residential property sector, focusing on the impact of government intervention and market fluctuations. The research shows that the housing market is highly sensitive to external factors. It highlights the central role of the National Bank of Poland (NBP) in shaping the housing market through changes in interest rates and credit availability. The COVID-19 pandemic temporarily disrupted developer activity and housing demand, highlighting the vulnerability of the market to unexpected shocks. In addition to observations, this study calls for a critical analysis of housing policies, identifying potential shortcomings and offering recommendations for improvement. It underlines that economic crises are an inherent part of housing market cycles, promoting market cleansing and healthy competition. Finally, this research emphasises that the housing market is intertwined with broader economic trends. It highlights the need for central banks to strike a balance between managing inflation and supporting economic growth. This study contributes to a deeper understanding of the relationship between the housing market and the business cycle, providing valuable insights for policymaking and investment decisions.
... It is known that there have been changes in BCs over the years. As stated by Crowley and Hallett (2018), a classic example would be the "great moderation" that appeared to smooth BCs in the early 1980s. This phenomenon was explained by several factors, such as financial innovation (Davis and Kahn, 2008) or demography (Heer et al., 2017). ...
... Forecasting business cycles is therefore an important factor to consider when managing construction projects. Business cycles refer to the overall state of the economy as it moves through four stages in a cyclical pattern: the expansion, peak, contraction, and trough [67][68][69]. The alternating phases of the business cycle are expansions and contractions (also known as recessions) [70]. ...
This study examines the dynamic relationship between the business cycle and the construction sector activity in 27 EU countries, focusing on Poland. Using the cross-correlation function (CCF) and a set of economic- and construction-related variables, including GDP growth, construction production, building permits, and construction operating time by backlog, quarterly data from 2000Q1 to 2023Q2 (94 quarters in total) are analyzed. Beyond the CCF analysis, causality is also examined using Toda–Yamamoto tests to explore the nuanced temporal relationships between GDP growth and construction activity proxies. The research uncovers synchronized positive lag max results for construction production, suggesting a harmonized response to broader economic changes, especially within 9 to 11 quarters. In contrast, building permits and construction time by backlog show divergent positive lag max values, suggesting the need for tailored, localized strategies. Negative lag max values emphasize the anticipatory role of the construction sector as an early indicator of economic change. Overcoming methodological challenges, this study provides insights critical for policymakers and researchers, promoting a nuanced understanding of economic synchrony and guiding informed strategies for sustainable development. Future recommendations include refining localized strategies based on lag patterns for optimal economic management.
... Then, Okun's Law can be stable for some cycles (frequencies) while being unstable for others depending on the speed of recovery and the strength of a shock/recession. The output growth volatility transfer from short run cycles (1-4 years) to long run cycles (8-16 years) during the Great Moderation period has been observed [22,23]. These results can explain some variability in Okun's coefficients across time while supporting the frequency hypothesis. ...
In this paper, we use the time-frequency wavelet estimators to analyze the robustness of Okun's Law in the European Union across time and within various economic cycles. We extend the Okun's Law literature as we focus on Europe, directly estimating the time-frequency varying Okun's coefficient. We observe that Okun's coefficient in Europe is unstable at short run (infra and annual cycles). The strength of Okun's Law is time dependent at short run as linkages between growth and unemployment are stronger only during crisis times. Such instability is explained as unemployment predominates growth, leading to a positive coefficient and weaker strength. However, as the frequencies increase, the coefficient is more stable over time and the strength is higher and homogenous over time.
... Crowley and Hughes Hallett (2018) established that the Great Moderation is characterized by a transfer of volatility of output growth from the short-end of business cycles (cycles with up to 4 years) to longer cycles. ...
... Based on the results, bilateral trade is not becoming more environmentally unfriendly over time. Crowley and Hallett (2018) investigated the transfer mechanism of volatility from high-frequency business cycles to low-frequency business cycles in the United States using classical monetary models and the New Keynesian model. According to the results, decreased inflation and output stability aided the transition from shorter to longer cycles. ...
This study investigates the empirical impact of China-Pak business cycle synchronization, urbanization, foreign direct investment, exports, and imports on environmental degradation in Pakistan from 1975 to 2017. In doing so, we use the Hodrick-Prescott filter to obtain the trend component of GDP. Then the trend component is subtracted from the original series of GDP to capture the cyclical component of China and Pakistan. The business cycle synchronization index is used to estimate synchronization between the business cycles of both countries. Using the ARDL method, we investigate the existence of a long-run co-integration relationship between the variables of interest. The empirical findings indicate that all explanatory variables (except FDI) are found to be significant factors of environmental degradation in the model. Furthermore, both imports and urbanization have a positive and significant impact on environmental degradation in Pakistan. At the same time, China-Pak business cycle synchronization and exports are discovered to have negative and significant coefficients for environmental degradation in Pakistan. The negative and significant ECM value indicates model convergence and a short-run relationship. The findings of the study suggest that improvement in China-Pak business cycle synchronization may be a factor that promotes environmental sustainability in Pakistan. An increase in exports and a decrease in imports can significantly contribute to reducing environmental degradation in Pakistan. A favorable balance of payment can provide sufficient financial prosperity to take environmental preservation measures. Policymakers should create effective urban planning, which has the potential to improve the country’s environmental quality.
... Blanchard, 1997). Crowley and Hughes-Hallett (2018) imply the existence of embedded lower frequencies in real market variables. Although we do not have a comprehensive theory of why intermediate time scales may capture the ''effective'' time horizon of labor market variables, a few explanations are associated with this evidence. ...
The debate on the inflation-unemployment relationship has focused almost exclusively on the distinction between the “short-run” and “long-run” Phillips curves, while virtually ignoring the ”middle” horizons. Using a historical perspective, we show that the UK wage Phillips curve is essentially a medium-run phenomenon. At the frequency range beyond business cycle frequencies, that is 8 to 16 years, there is significant evidence of a negative and stable relationship between money wage inflation and unemployment.
... That is why, the intent of this paper is to study BCs and FCs co-movement, synchronicity and convergence within and between the EZ state memberss over time but mostly across frequencies. Indeed, as we will see in the next section, most studies focused on the synchronization between cycles over time but only a few of them study them across frequencies (Crowley and Hallett, 2018;Yan and Haung, 2020). ...
This paper examines the Eurozone (EZ) convergence through Financial and Business cycles frequencies over time. Specifically, I use the Maximum Overlap Discrete Wavelet Transform (MODWT) in order to analyze whether financial cycles on the one hand and business cycles on the other hand are inter-countries synchronized, interconnected, interrelated and co-variant across time and frequencies. I also study if Financial and Business cycles are intra-countries synchronized, interconnected, interrelated, co-variant and phased across time and frequencies. I find that: (i) the EZ is mostly divergent at short term; (ii) the monetary policy led to a boom period between 2002 and 2006 that masked the already existing divergences in the EZ; (iii) that business and financial cycles grew in a case-by-case macroeconomic and financial environment which led to an exacerbation of the divergences; (iv) the lack of synchronization at all frequencies and over time intra-country and inter-country precludes the monetary policy to play its countercyclical role.
... Rua (2012) used wavelet analysis to analyze money and prices in the euro area and found a strong link between inflation and money growth at low frequencies over the whole sample period, but that at the typical business cycle frequency range the link is only present until the beginning of the 1980s, indicating a shift that occurred coincident with the "great moderation". Crowley and Hughes Hallett (2015), using discrete wavelet analysis as applied to both the US and the UK, showed that the shift was a change in volatility from shorter cycles to longer cycles, and then subsequently Crowley and Hughes Hallett (2018) showed, using theoretical monetary models, why volatility transfers from higher to lower frequency cycles occur, causing the business cycle to elongate and intensify, and how they could reverse. The results showed that an increase in inflation aversion or a reduction in the commitment to output stabilization by the central bank would create volatility transfers sufficient to give rise to a "great moderation", while a reversal of those commitments would take it away again. ...
It has recently been widely recognized that monetary policy objectives change through time as our understanding of monetary policy and its impact on the macroeconomy evolves. In recent years there has been an extensive review of the framework for monetary policy at major central banks around the world, given the practical problems that have been encountered with inflation targets. This paper is a contribution to this debate, in that the aim of this paper is to evaluate the consequences of adopting different monetary policy objectives in the U.S. macroeconomic policy setting. To accomplish this, we first decompose U.S. macroeconomic data using a time-frequency domain technique, namely discrete wavelet analysis. We then model the behavior of the U.S. economy over each wavelet frequency range and use our estimated parameters to construct a tracking model. To illustrate the usefulness of this approach, we simulate jointly optimal fiscal and monetary policy with different short-term monetary targets: an inflation target, a money growth target, an interest rate target, and a real economic growth target. The results show that the most effective monetary policy targets to achieve economic growth are either inflation targets or economic growth targets.
... Crowley and Hughes Hallett (2018) established that the Great Moderation has been characterized by a transfer of volatility of output growth from the short-end of business cycles (cycles with up to 4 years) to long cycles (longer than 16 years) and maybe even intermediate-frequency business cycles (between 4 and 8 years) and medium-run cycles (8 to 16 years). Such volatility transfer seems associated with the stronger reaction of monetary policy to in ‡ation since the mid-1980s. ...
... A third and very likely possibility is the power of the different cycles that constitute the GDP component pairs that we are looking at can vary over time depending on; the type and timing of shocks that hit the economy; on the parameters that control the dynamics of that economy; and most importantly on any changes in the policy rules that get applied to that economy. In earlier work (Crowley & Hughes Hallett, 2018) we have given a number of worked examples to show how easily that can happen in our standard models. Fairly obviously, if events do conspire to weaken the power of certain cycles, or to extend them to a different length, then the coherence of a GDP component principally composed of that cycle will be reduced numerically, together with other components whose cycles (power, length) are not affected or equally affected. ...
Understanding the relationship between national income GDP expenditure components is a key part of the study of macroeconomics. The general aim of this study is to explore the relationship between the GDP expenditure components in the time-frequency domain and obtain some stylized facts. This research investigates the relationship between the cyclical components of growth in quarterly real GDP component data for the US and the UK by applying continuous wavelet analysis on cross comparisons of the data, from both within and between the two datasets. The results show that the cyclical interactions between consumption and investment are the most complex and most substantial at several different frequencies, but that there are several different cycles evident in the data at frequencies not associated with the conventional business cycle. The relationship of exports with other macroeconomic variables has also developed over time, which we surmise is likely due to the evolution of an international business cycle.
... growth. Thus, unidirectional linkage between economic growth and human development was found. The study confirmed that sustainable economic growth was possible through achieving human development and for this instance results concluded that trade openness was important factor to improve both the economic growth and human development simultaneously.Crowley and Hallett (2018) used Classical monetary models and New Keynesian model and explained the mechanism of transfer of volatility from high frequency business cycles to low frequency business cycles in United States. Results concluded that transition of shorter cycles to longer cycles was mainly encouraged through decrease in inflation and reduction in outp ...
This study has examined the potential impact of China-Pak business cycle synchronization on human development in Pakistan. Data covered the time span of 1975-2017. Other independent variables include inflation, GDP per capita, external debt and FDI. Results of unit root test showed that all variables were stationary with mixture of level and first difference. F-bounds test confirmed the presence of long run relationship among the variables. ARDL technique was applied to obtain long run coefficients. The study found that FDI and GDP per capita had positive and significant impact on human development while China-Pak business cycle synchronization, inflation and external debt had negative and significant relationship with human development in Pakistan. Results showed the value of error correction term -0.16 with 1 percent level of significance which confirmed the presence of short run equilibrium in the model. All independent variables had significant relationship with human development in the short run. CUSUM and CUSUMSQ stability tests showed that parameters of the model were stable. The study suggested that government should focus critically China-Pak business cycle synchronization to uplift human development in Pakistan for which domestic production should be promoted to facilitate domestic producers that might be helpful to improve employment level which finally can raise human development. Control on inflation is significant for the sake of human development. Policy makers should take steps for improvement in GDP per capita and FDI to encourage human development in Pakistan.
... In comparing with Aguiar-Conraria et al. (2020), the results are qualitatively similar, with the transition date from the higher-frequency mode to the lower-frequency mode occurring a little later (in roughly 1982), but the power of the lower-frequency fluctuations appears to fade through time to essentially disappear by 2015. In terms of the cause of this modal shift in power from medium-term to longerterm macroeconomic cycles, this was first identified by Crowley and Hughes Hallett (2015) and then Crowley and Hughes Hallett (2018) offered an economic explanation for this phenomenon based on the New Keynesian and classical theoretical models. The model in Eqs. ...
This paper integrates the Okun’s law (OL) relationship into a wavelet-based control (WBC) model to compare simulated optimal fiscal and monetary policy for the US when the policymakers place varying emphasis on the primary macroeconomic targets of unemployment, output growth, and inflation. The simulation results show that the unemployment rate is impacted differently across frequency ranges. We find that fiscal policy is the most aggressive when economic growth is emphasized as a policy objective, whereas monetary policy is relatively more aggressive when the inflation rate is emphasized. Given that the US inflation rate was below target for the start of the simulation exercises, when it is emphasized, that leads to lower interest rates, a depreciated exchange rate, and larger aggregate investment. We also find that introducing OL into a WBC model leads to less expansionary fiscal and monetary policies when unemployment is initially low.
... While Okun's coefficient may have been unstable across time, it is likely that it has also been unstable for different frequencies. Not only there is evidence that cycles longer than those associated with business cycle frequencies display relevant information for macroeconomic analysis (Pancrazi, 2015), but there is also evidence of a lengthening of business cycles (Aguiar-Conraria, Martins and Soares, 2018, and Crowley and Hallett, 2018). If such volatility transfer has been caused by a change in policy preferences, then it very likely has also affected other main macroeconomic variables, such as the unemployment rate, and their relation with output. ...
We present the first assessment of U.S. Okun’s Law across time and frequencies. We use a set of continuous wavelet tools that allows for estimating Okun’s coefficient and the lead/lag of output over unemployment at each moment and for each cyclical frequency. We find similar results for the gaps and the first differences specifications at business cycles frequencies, but not at lower frequencies. Okun’s coefficient has increased (in absolute value) since the mid-1960s, except in 1985-1995, and is not particularly sensitive to recessions. The lead of output varies considerably over time and also at different frequencies. We observe (especially with the gaps specification) that there are at least two cyclical processes relevant for the Okun’s relationship, one at the business cycle and another at lower frequencies. Methods that do not take this into account are bound to mix the information embedded in both cycles.
... The early papers in economics using wavelets (Ramsey and Lampart, 1998a,b) rely on the discrete wavelet transform. Recent papers using the discrete wavelet transform include Gallegati et al. (2011), Crowley and Hallett (2018) and Faria and Verona (2018). different frequencies. ...
The investment literature has long acknowledged the time‐ and frequency‐varying dynamics of the relationship between investment, Tobin's Q and cash flow. In this paper, we use continuous wavelet tools to estimate and assess the relationship between these variables simultaneously at different frequencies and over time. We find that (i) Q and cash flow are complementary sources of information for investment, the former being more important for firms’ investment decisions in the medium‐to‐long run and the latter at business cycles frequencies; and (ii) investment‐Q sensitivity declines over time at all frequencies, while investment–cash flow sensitivity declines at business cycles frequencies but remains largely stable over the medium‐to‐long run.
... I approximate those with the median of business cycle moments of the eight countries in the dataset (in order to wash out shifts that are likely idiosyncratic) as the dependent variable in my regressions. At the same time, though, I also consider the potential (non-linear) 12 A further structural evaluation of the linkages between volatility transfers and the duration, frequency, and depth of business cycles through the lens of the New Keynesian model can be found in Crowley and Hallett (2018). 13 Volume estimates of Gross Domestic Product by expenditure type (market prices in local currency) were taken from the OECD's Outlook database. ...
In this paper, I explore the changes in international business cycles with quarterly data for the eight largest advanced economies (US, UK, Germany, France, Italy, Spain, Japan, and Canada) since the 1960s. Using a time-varying parameter model with stochastic volatility for real GDP growth and inflation allows their dynamics to change over time, approximating nonlinearities in the data that otherwise would not be adequately accounted for with linear models [Granger, Clive W.J., Timo Teräsvirta, and Heather M. Anderson. 1991. “Modeling Nonlinearity over the Business Cycle.” In NBER book Business Cycles, Indicators and Forecasting (1993) , edited by James H. Stock and Mark W. Watson, University of Chicago Press.; Granger, Clive W.J. 2008. “Non-Linear Models: Where Do We Go Next – Time Varying Parameter Models?” Studies in Nonlinear Dynamics and Econometrics 12 (3): 1–11.]. With that empirical model, I document a period of declining macro volatility since the 1980s, followed by increasing (and diverging) inflation volatility since the mid-1990s. I also find significant shifts in inflation persistence and cyclicality, as well as in macro synchronization and even forecastability. The 2008 global recession appears to have had an impact on some of this. I ground my empirical strategy on the reduced-form solution of the workhorse New Keynesian model and, motivated by theory, explore the relationship between greater trade openness (globalization) and the reported shifts in international business cycle. I show that globalization has sizeable (yet nonlinear) effects in the data consistent with the implications of the model – yet globalization’s contribution is not a foregone conclusion, depending crucially on more than the degree of openness of the international economy.
... I approximate those with the median of business cycle moments of the eight countries in the dataset (in order to wash out shifts that are likely idiosyncratic) as the dependent variable in my regressions. At the same time, though, I also consider the potential (non-linear) 12 A further structural evaluation of the linkages between volatility transfers and the duration, frequency, and depth of business cycles through the lens of the New Keynesian model can be found in Crowley and Hallett (2018). 13 Volume estimates of Gross Domestic Product by expenditure type (market prices in local currency) were taken from the OECD's Outlook database. ...
In this paper, I explore the changes in international business cycles with quarterly data for the eight largest advanced economies (U.S.) since the 1960s. Using a time-varying parameter model with stochastic volatility for real GDP growth and inflation allows their dynamics to change over time, approximating nonlinearities in the data that otherwise would not be adequately accounted for with linear models (Granger et al. (1991), Granger (2008)). With that empirical model, I document a period of declining macro volatility since the 1980s, followed by increasing (and diverging) inflation volatility since the mid-1990s. I also find significant shifts in inflation persistence and cyclicality, as well as in macro synchronization and even forecastability. The 2008 global recession appears to have had an impact on some of this. I ground my empirical strategy on the reduced-form solution of the workhorse New Keynesian model and, motivated by theory, explore the relationship between greater trade openness (globalization) and the reported shifts in international business cycle. I show that globalization has sizeable (yet nonlinear) effects in the data consistent with the implications of the model-yet globalization's contribution is not a foregone conclusion, depending crucially on more than the degree of openness of the international economy.
This paper uses wavelet coherencies and a wavelet dissimilarity index to study the similarities and synchronization of government bond yield movements in the G7. Using monthly data, going from January 1980 to September 2018, the analysis finds a high degree of synchronization among the seven government bond yield series. The Great Recession is associated with breaks in several time-frequency regions of statistically significant coherencies. The European convergence process and the introduction of the euro are associated with more statistically significant time-frequency regions of high coherencies among the euro area countries. Language, economic , and political factors appear to exert influence on the degree of synchronization between countries, as a higher level of synchronization is observed amongst the anglophone countries and the euro area countries.
We introduce a new hybrid approach to joint estimation of Value at Risk (VaR) and Expected Shortfall (ES) for high quantiles of return distributions. We investigate the relative performance of VaR and ES models using daily returns for sixteen stock market indices (eight from developed and eight from emerging markets) prior to and during the 2008 financial crisis. In addition to widely used VaR and ES models, we also study the behavior of conditional and unconditional extreme value (EV) models to generate 99 percent confidence level estimates as well as developing a new loss function that relates tail losses to ES forecasts. Backtesting results show that only our proposed new hybrid and Extreme Value (EV)-based VaR models provide adequate protection in both developed and emerging markets, but that the hybrid approach does this at a significantly lower cost in capital reserves. In ES estimation the hybrid model yields the smallest error statistics surpassing even the EV models, especially in the developed markets.
I distinguish two types of macroeconomic models. The first type are top-down models in which some or all agents are capable
of understanding the whole picture and use this superior information to determine their optimal plans. The second type are
bottom-up models in which all agents experience cognitive limitations. As a result, these agents are only capable of understanding
and using small bits of information. These are models in which agents use simple rules of behavior. These models are not devoid
of rationality. Agents in these models behave rationally in that they are willing to learn from their mistakes. These two
types of models produce a radically different macroeconomic dynamics. These differences are analyzed in this article. (JEL
codes: E10, E32, D83)
This paper estimates and solves a multi-country version of the standard DSGE New Keynesian (NK) model. The country-specific models include a Phillips curve determining inflation, an IS curve determining output, a Taylor Rule determining interest rates, and a real effective exchange rate equation. The IS equation includes a real exchange rate variable and a country-specific foreign output variable to capture direct inter-country linkages. In accord with the theory all variables are measured as deviations from their steady states, which are estimated as long-horizon forecasts from a reduced-form cointegrating global vector autoregression. The resulting rational expectations model is then estimated for 33 countries on data for 1980Q1-2006Q4, by inequality constrained IV, using lagged and contemporaneous foreign variables as instruments, subject to the restrictions implied by the NK theory. The multi-country DSGE NK model is then solved to provide estimates of identified supply, demand and monetary policy shocks. Following the literature, we assume that the within country supply, demand and monetary policy shocks are orthogonal, though shocks of the same type (e.g. supply shocks in different countries) can be correlated. We discuss estimation of impulse response functions and variance decompositions in such large systems, and present estimates allowing for both direct channels of international transmission through regression coefficients and indirect channels through error spillover effects. Bootstrapped error bands are also provided for the cross country responses of a shock to the US monetary policy.
This article explores the links between cyclical fluctuations and long-run growth in the context of an endogenous growth model with aggregate demand externalities. In this model, aggregate demand and growth rates are positively correlated. In the presence of exogenous cyclical shocks, the model is able to generate persistent fluctuations through the effects that business cycles have on aggregate demand, profits and technological progress. Persistence becomes a measure of the response to business cycles of growth-related variables. Empirical evidence from a large sample of countries suggests that there is indeed a correlation between how persistent fluctuations are and the long-term growth rates of GDP. Copyright 2000 by Kluwer Academic Publishers
We present the first assessment of U.S. monetary policy across time and frequencies within the Taylor Rule framework. We derive a novel wavelet tool — the partial wavelet gain — to estimate a parametric equation relating the federal funds rate to inflation and the output gap. We detect a gradual shift of the focus of policy from short cycles to intermediate cycles at the beginning of the Great Moderation, followed by a strengthening of policy's reaction to long fluctuations once credibility was attained, and, during the Great Recession, a renewed interest in shorter output cycles. We document that the violation of the Taylor principle until the early 1980s and the strengthening of the reaction of policy to inflation thereafter were more marked at intermediate than at long cycles. Overall, we also detect lead-lag relationships between the policy rate and inflation and the output gap that differ along time and cyclical frequencies.
The stabilization of economic activity in the mid 1980s has received considerable attention. Research has focused primarily on the role played by milder economic shocks, improved inventory management, and better monetary policy. This paper explores another potential explanation: financial innovation. Examples of such innovation include developments in lending practices and loan markets that have enhanced the ability of households and firms to borrow and changes in government policy such as the demise of Regulation Q. We employ a variety of simple empirical techniques to identify links between the observed moderation in economic activity and the influence of financial innovation on consumer spending, housing investment, and business fixed investment. Our results suggest that financial innovation should be added to the list of likely contributors to the mid-1980s stabilization.
Many indicators of business and growth cycles have been constructed by both private and public agencies and are now in use as monitoring devices of economic conditions and for forecasting purposes. As these indicators are largely composite constructs using other economic data, their frequency composition is likely different to that of the variables that they are used as for indicators.
Embedding survey expectations in a standard DSGE model helps to identify key slope parameters in standard relationships; dramatically reduces the need for lagged dependent variables, often motivated by price-indexation and habit formation; and obviates the need for autocorrelated structural shocks in the key equations. Formal statistical tests demonstrate that much of the persistence in aggregate data is better accounted for by slow-moving expectations, rather than by habits, indexation and autocorrelated structural shocks.
According to empirical studies, the life cycle of labor supply volatility exhibits a U-shaped pattern. This may lead to the conclusion that demographic change induces a drop in output volatility. We present an overlapping-generations model that replicates the empirically observed pattern and study the impact of demographic transition on output volatility. We find that the change in age composition itself has only a marginal influence on output volatility, as the mitigating effect of more individuals with lower labor supply volatilities is compensated for by higher age-specific labor shares. Instead, the driving force behind the Great Moderation in our model is the downward shift of the age-specific labor supply volatility curve.
From 1960 to 1983, the standard deviation of annual growth rates in real GDP in the United States was 2.7%. From 1984 to 2001, the corresponding standard deviation was 1.6%. This paper investigates this large drop in the cyclical volatility of real economic activity. The paper has two objectives. The first is to provide a comprehensive characterization of the decline in volatility using a large number of U.S. economic time series and a variety of methods designed to describe time-varying time-series processes. In so doing, the paper reviews the literature on the moderation and attempts to resolve some of its disagreements and discrepancies. The second objective is to provide new evidence on the quantitative importance of various explanations for this "great moderation." Taken together, we estimate that the moderation in volatility is attributable to a combination of improved policy (20-30%), identifiable good luck in the form of productivity and commodity price shocks (20-30%), and other unknown forms of good luck that manifest themselves as smaller reduced-form forecast errors (40-60%).
Empirical Mode Decomposition (EMD) was developed late last century, but has still to be introduced to the vast majority of economists. EMD was originally one of the components of Hilbert Huang Transform (HHT) which was a process of extracting the frequency mode features of cycles embedded in any time series using an adaptive data method which can be applied without making any assumption about stationarity or linear data-generating properties of time series. This paper introduces economists to the two constituent parts of the HHT transform, namely EMD and the Hilbert Spectrum, and also a new variant of this methodology, Ensemble EMD (EEMD). Several illustrative applications using the methodology are also included.
In this paper the relationship between the growth of real GDP components at different cycle lengths is explored in the frequency domain using discrete wavelet analysis. This analysis is done for both the US and the UK using quarterly data, and the results reveal interesting differences in the two countries. One of the key findings is that the ”great moderation” shows up only at certain frequencies, and not in all components of real GDP. A second result is that the great moderation appears to have shifted cyclical power from shorter and business cycles to long cycles, which has important implications for both policy formulation and the probability of less frequent but more severe economic crises. We use these results to explain why the incidence of the great moderation has been so ephemeral across GDP components, countries and time periods. This also explains why it has been so hard to detect periods of moderation (or otherwise) reliably in the aggregate data.
Developing a new and highly innovative theory of economic policy, this book deals with conflicts between strategic actions by public and private agents. It builds on the Lucas critique but also applies the tools introduced by Tinbergen and Theil to dynamic policy games and from there derives a new theory of economic policy. Its main propositions describe such properties in the models currently used for policy-making as neutrality and equilibrium existence; uniqueness; and multiplicity. These properties are key to understanding the impact of concepts such as rational expectations, time inconsistency, communication and the use of policy announcements. As the numerous examples show, they are useful both for model building and for devising optimal institutions. The Theory of Economic Policy in a Strategic Context is an essential but accessible tool for economic researchers involved in policy questions. © Nicola Acocella, Giovanni Di Bartolomeo and Andrew Hughes Hallett 2013.
We reformulate the Smets-Wouters (2007) framework by embedding the theory of unemployment proposed in Gali (2011b, 2011c). We estimate the resulting model using postwar US data, while treating the unemployment rate as an additional observable variable. Our approach overcomes the lack of identification of wage markup and labor supply shocks highlighted by Chari, Kehoe, and McGrattan (2008) in their criticism of New Keynesian models, and allows us to estimate a "correct" measure of the output gap. In addition, the estimated model can be used to analyze the sources of unemployment fluctuations.
This paper provides new insights on the relationship between money growth and inflation in the euro area over the last forty years. This highly relevant link for the European Central Bank monetary policy strategy is assessed using wavelet analysis. In particular, wavelet analysis allows to study simultaneously the relationship between money growth and inflation in the euro area at the frequency level and assess how it has changed over time. The findings indicate a stronger link between inflation and money growth at low frequencies over the whole sample period. At the typical business cycle frequency range the link is only present until the beginning of the 1980’s. Moreover, there seems to be a recent deterioration of the leading properties of money growth with respect to inflation in the euro area. These results highlight the importance of a regular assessment of the role of money growth in tracking inflation developments in the euro area since such relationship varies across frequencies and over time.
The costs of uncoordinated fiscal and monetary policies involve more than just efficiency losses. Of course there will be the usual efficiency losses associated with noncooperative decision making and they have appeared here. But these are not the main costs. A lack of cooperation between the government and the central bank also imposes a policy conflict which would not otherwise exist. A lack of co-operation provides one player (the central bank) with the opportunity to block the policy options of the other (the government). Hence noncooperation can cost the government its freedom to choose its preferred policy option.
These two costs, additional policy conflicts and the loss of policy choice, may be more important than the efficiency losses which are traditionally cited as the reason for cooperating. In any case, they will have important implications both for domestic policy design and for international policy making since central banks evidently find it easier to cooperate among themselves than they do with their own (national) fiscal authorities. Thus, an independent central bank may be necessary to guarantee financial discipline, but it will not be much help if it and the fiscal authorities then fail to coordinate their activities.
We use wavelet analysis to study business cycle synchronization across the EU-15 and the Euro-12 countries. Based on the wavelet transform, we propose a metric to measure and test for business cycles synchronization. Several conclusions emerge. France and Germany form the core of the Euro land, being the most synchronized countries with the rest of Europe. Portugal, Greece, Ireland and Finland do not show statistically relevant degrees of synchronization with Europe. We also show that some countries (like Spain) have a French accent, while others have a German accent (e.g., Austria). Perhaps surprisingly, we find that the French business cycle has been leading the German business cycle as well as the rest of Europe. Among the countries that may, in the future, join the Euro, the Czech Republic seems the most promising candidate.
Although widely used in many areas of applied sciences, wavelet analysis has not fully entered the economic discipline yet. In this article we apply wavelet analysis to one of the most investigated relationships is in empirical macroeconomics: the relationship between wage inflation and unemployment. Using US postwar data we find a frequency‐dependent relationship of a sort that is consistent with Phillips’ original insights. It also turns out that this relationship is remarkably stable over the 1948-93 period, but not in the aftermath, as a consequence of a process of adaption of the wage formation process to a low inflation environment.
Galí and Gertler [1999. Inflation dynamics: a structural econometric approach. Journal of Monetary Eonomics 44(2), 195–222] developed a hybrid variant of the New Keynesian Phillips curve that relates inflation to real marginal cost, expected future inflation and lagged inflation. GMM estimates of the model suggest that forward-looking behavior is dominant: the coefficient on expected future inflation substantially exceeds the coefficient on lagged inflation. While the latter differs significantly from zero, it is quantitatively modest. Several authors have suggested that our results are the product of specification bias or suspect estimation methods. Here we show that these claims are incorrect, and that our results are robust to a variety of estimation procedures, including GMM estimation of the closed form, and nonlinear instrumental variables. Also, as we discuss, many others have obtained very similar results to ours using a systems approach, including FIML techniques. Hence, the conclusions of GG and others regarding the importance of forward-looking behavior remain robust.
In this paper, we develop a dynamic stochastic general equilibrium (DSGE) model for an open economy, and estimate it on Euro area data using Bayesian estimation techniques. The model incorporates several open economy features, as well as a number of nominal and real frictions that have proven to be important for the empirical fit of closed economy models. The paper offers: i) a theoretical development of the standard DSGE model into an open economy setting, ii) Bayesian estimation of the model, including assessments of the relative importance of various shocks and frictions for explaining the dynamic development of an open economy, and iii) an evaluation of the model's empirical properties using standard validation methods.
Society can sometimes make itself better off by appointing a central banker who does not share the social objective function,
but instead places “too large” a weight on inflation-rate stabilization relative to employment stabilization. Although having
such an agent head the central bank reduces the time-consistent rate of inflation, it suboptimally raises the variance of
employment when supply shocks are large. Using an envelope theorem, we show that the ideal agent places a large, but finite,
weight on inflation. The analysis also provides a new framework for choosing among alternative intermediate monetary targets.
Most advanced economies have experienced a striking decline in the volatility of aggregate economic activity since the early 1980s. Volatility reductions are evident for output and employment at the aggregate level and across most industrial sectors and expenditure categories. Inflation and inflation volatility have also declined dramatically. Previous studies offer several potential explanations for this "Great Moderation." We review evidence on the Great Moderation in conjunction with evidence about volatility trends at the micro level. We combine the two types of evidence to develop a tentative story for important components of the aggregate volatility decline and its consequences. The key ingredients are declines in firm-level volatility and aggregate volatility—most dramatically in the durable goods sector. Surprisingly, this has occurred without a decline in household consumption volatility and individual earnings uncertainty. Our explanation for the aggregate volatility decline stresses improved supply-chain management, particularly in the durable goods sector, and, less important, a shift in production and employment from goods to services. We provide evidence that better inventory control made a substantial contribution to declines in firm-level and aggregate volatility. Consistent with this view, if we look past the turbulent 1970s and early 1980s much of the moderation reflects a decline in high frequency (short-term) fluctuations. While these developments represent efficiency gains, they do not imply (nor is there evidence for) a reduction in economic uncertainty faced by individuals and households.
We introduce a new hybrid approach to joint estimation of Value at Risk (VaR) and Expected Shortfall (ES) for high quantiles of return distributions. We investigate the relative performance of VaR and ES models using daily returns for sixteen stock market indices (eight from developed and eight from emerging markets) prior to and during the 2008 financial crisis. In addition to widely used VaR and ES models, we also study the behavior of conditional and unconditional extreme value (EV) models to generate 99 percent confidence level estimates as well as developing a new loss function that relates tail losses to ES forecasts. Backtesting results show that only our proposed new hybrid and Extreme Value (EV)-based VaR models provide adequate protection in both developed and emerging markets, but that the hybrid approach does this at a significantly lower cost in capital reserves. In ES estimation the hybrid model yields the smallest error statistics surpassing even the EV models, especially in the developed markets.
This paper examines the role of output stabilization in the conduct of monetary policy. It argues that activist monetary policy--in which the monetary authorities focus on output fluctuations in the setting of their policy instrument and in policy statements--is likely to produce worse outcomes for output and inflation fluctuations, because it will lead to suboptimal monetary policy, but also because it complicates monetary authorities' communication strategy and can weaken the credibility of the central bank. In contrast, conducting monetary policy with a flexible inflation target rule is likely to produce better outcomes. A flexible inflation target rule also allows the monetary authorities to communicate effectively to the public that they do care about output fluctuations, but makes it less likely that they will be encouraged to try to exploit the short-run trade-off between output and inflation.
Copyright 2002 by Blackwell Publishers Ltd.
This paper calculates indices of central bank autonomy (CBA) for 163 central banks as of end-2003, and comparable indices for a subgroup of 68 central banks as of the end of the 1980s. The results confirm strong improvements in both economic and political CBA over the past couple of decades, although more progress is needed to boost political autonomy of the central banks in emerging market and developing countries. Our analysis confirms that greater CBA has on average helped to maintain low inflation levels. The paper identifies four broad principles of CBA that have been shared by the majority of countries. Significant differences exist in the area of banking supervision where many central banks have retained a key role. Finally, we discuss the sequencing of reforms to separate the conduct of monetary and fiscal policies. IMF Staff Papers (2009) 56, 263–296. doi:10.1057/imfsp.2008.25; published online 23 September 2008
This paper develops and estimates a stochastic dynamic general equilibrium (SDGE)model with sticky prices and wages for the euro area. The model incorporates various other features such as habit formation, costs of adjustment in capital accumulation and variable capacity utilisation. It is estimated with Bayesian techniques using seven key macro-economic variables: GDP, consumption, investment, prices, real wages, employment and the nominal interest rate. The introduction of ten orthogonal structural shocks (including productivity, labour supply, investment, preference, cost-push and monetary policy shocks) allows for an empirical investigation of the effects of such shocks and of their contribution to business cycle fluctuations in the euro area. Using the estimated model, the paper also analyses the output (real interest rate) gap, defined as the difference between the actual and model-based potential output (real interest rate). JEL Classification: E4; E5.
Introduction John Taylor (1993) has proposed that U.S. monetary policy in recent years can be described by an interest-rate feedback rule of the form i t = .04 + 1.5(# t - .02) + .5(y t - y t ), (1.1) where i t denotes the Fed's operating target for the federal funds rate, # t is the inflation rate (measured by the GDP deflator), y t is the log of real GDP, and y t is the log of "potential output" (identified empirically with a linear trend). ). The rule has since been subject to considerable attention, both as an account of actual policy in the U.S. and elsewhere, and as a prescription for desirable policy. Taylor argues for the rule's normative significance both on the basis of simulations and on the
Evaluating an estimated New Keynesian small open economy model
- M Adolfson
- S Lasen
- M Lind
- M Villani
Adolfson, M., Lasen, S., Lind, M., Villani, M., 2008. Evaluating an estimated New Keynesian small open economy model. J. Econ. Dyn. Control 32 (8), 2690-2721.
Frequency-specific effects of monetary policy rules
- W Brock
- S Durlauf
- G Rondina
Brock, W., Durlauf, S., Rondina, G., 2008. Frequency-specific effects of monetary policy rules. Am. Econ. Rev. (Pap. Proc.) 98 (2), 241-245.
New Keynesian Optimal-policy Models: An Empirical Assessment. Federal Reserve Bank of San Francisco Discussion Paper
- R Dennis
Dennis, R., 2004. New Keynesian Optimal-policy Models: An Empirical Assessment. Federal Reserve Bank of San Francisco Discussion Paper 2004-17.
Have Europes Labour Markets Become More Flexible? an Exercise in Measuring Relative Flexibility across Countries and Time
- A Hughes Hallett
- C Richter
- N Jaimovich
- H Siu
Hughes Hallett, A., Richter, C., 2008. Have Europes Labour Markets Become More Flexible? an Exercise in Measuring Relative Flexibility across Countries and Time. In: van Aarle,
B., Weyerstrass, K. (Eds.), Economic Spillovers, Structural Reforms and Policy Coordination in the Euro Area. Physica Verlag/Springer, Heidelberg.
Jaimovich, N., Siu, H., 2009. The young, the old, and the restless: demographics and business cycle volatility. Am. Econ. Rev. 99 (3), 804-826.
Taylor Rules. Board of Governors of the Federal Reserve System. Finance and Economics Discussion Paper
- A Orphanides
Orphanides, A., 2007. Taylor Rules. Board of Governors of the Federal Reserve System. Finance and Economics Discussion Paper 2007-18.
How Distinct are Financial Cycles from Business Cycles
- G Ruestler
Ruestler, G., 2016. How Distinct are Financial Cycles from Business Cycles. Research Bulletin. European Central Bank: based on Business, Housing and Credit Cycles, WP 1915,
European Central Bank, Frankfurt, Germany.
Comment: Real Adjustment and Exchange Rate Dynamics (Neary and Purvis)
- J Sachs
Sachs, J., 1983. Comment: Real Adjustment and Exchange Rate Dynamics (Neary and Purvis). Exchange Rates and International Macroeconomics. NBER, Cambridge, USA.
DSGE model-based estimation of the New Keynesian Phillips curve. Econ. Q. Federal Reserve Bank of Richmond 397-433
- F Schorfheide
Schorfheide, F., 2008. DSGE model-based estimation of the New Keynesian Phillips curve. Econ. Q. Federal Reserve Bank of Richmond 397-433. Federal Reserve Bank of
Richmond.