Trend-Cycle Decompositions of Real GDP Revisited: Classical and Bayesian Perspectives on an Unsolved Puzzle

31 Pages Posted: 12 Dec 2016 Last revised: 27 Apr 2018

See all articles by Chang-Jin Kim

Chang-Jin Kim

Dept. of Economics, University of Washington

Jaeho Kim

Korea Development Institute; University of Oklahoma

Date Written: April 2018

Abstract

While Perron and Wada’s (2009) maximum likelihood estimation approach suggests that postwar U.S. real GDP follows a trend stationary process (TSP), our Bayesian approach based on the same model and the same sample suggests that it follows a difference stationary process (DSP). We first show that the results based on the maximum likelihood approach should be interpreted with caution, as they are relatively more subject to the ‘pile-up problem’ than those based on the Bayesian approach.

We then directly estimate and compare the two competing TSP and DSP models of real GDP within the Bayesian framework. We focus on out-of-sample prediction performance of the two competing models, and we employ the predictive likelihood as a criterion for model comparison. We also compare the out-of-sample predictive power of the cyclical components implied by the two models estimated. Our empirical results suggest that a DSP model is preferred to a TSP model. Furthermore, the cycle from the DSP model, unlike the cycle from the TSP model, has out-of sample predictive power for future output growth and has information beyond the historical mean for output growth.

Keywords: Pile-Up Problem, Profile Likelihood, Integrated Likelihood, Trend Stationary Process, Difference Stationary Process, Out-Of-Sample Prediction, Spurious Periodicity

Suggested Citation

Kim, Chang-Jin and Kim, Jaeho and Kim, Jaeho, Trend-Cycle Decompositions of Real GDP Revisited: Classical and Bayesian Perspectives on an Unsolved Puzzle (April 2018). Available at SSRN: https://ssrn.com/abstract=2883438 or http://dx.doi.org/10.2139/ssrn.2883438

Chang-Jin Kim

Dept. of Economics, University of Washington ( email )

Department of Economics (Box 353330)
University of Washington
Seattle, WA 98195-3330
United States

HOME PAGE: http://https://econ.washington.edu/people/chang-jin-kim

Jaeho Kim (Contact Author)

Korea Development Institute ( email )

P.O. Box 113
Cheongryangri
Seoul 130-012
United States

University of Oklahoma ( email )

729 Elm Avenue
Norman, OK 73019-2103
United States

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