Friedman's Plucking Model of Business Fluctuations: Tests and Estimates of Permanent and Transitory Components
Korea University; Dept. of Economics, University of Washington
Charles R. Nelson
Dept of Economics
More than thirty years ago Milton Friedman proposed a "plucking" model of business fluctuations in which output cannot exceed a ceiling level, but will, from time to time, be plucked downward by recession. The model implied that business fluctuations are asymmetric, that recessions have only a temporary effect on output, and that recessions are duration dependent while expansions are not. Subsequent literature has provided copious empirical support for these propositions, but econometric models of business fluctuations have not incorporated these features. This paper presents a formal econometric model which encompasses both plucking and asymmetric fluctuations around a stochastic trend while allowing for heteroscedasticity and shocks to the growth rate. We find that U.S. real GDP is well characterized by Friedman's plucking model, that implied recessions correspond closely with NBER reference cycles, and no substantial role for symmetric cycles. Decomposition of the unemployment rate reveals a corresponding asymmetry and timing but with different dynamics. Time paths of the implied ceiling level of output and the trend rate of unemployment are presented.
Number of Pages in PDF File: 28
JEL Classification: E32
Date posted: April 28, 1999