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Permanent vs transitory components and economic fundamentals
Author(s) -
Garratt Anthony,
Robertson Donald,
Wright Stephen
Publication year - 2006
Publication title -
journal of applied econometrics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.878
H-Index - 99
eISSN - 1099-1255
pISSN - 0883-7252
DOI - 10.1002/jae.850
Subject(s) - weighting , economics , econometrics , observable , business cycle , multivariate statistics , series (stratigraphy) , component (thermodynamics) , stationary process , permanent income hypothesis , mathematical economics , macroeconomics , mathematics , statistics , thermodynamics , physics , paleontology , quantum mechanics , biology , market liquidity , acoustics
Any non‐stationary series can be decomposed into permanent (or ‘trend’) and transitory (or ‘cycle’) components. Typically some atheoretic pre‐filtering procedure is applied to extract the permanent component. This paper argues that analysis of the fundamental underlying stationary economic processes should instead be central to this process. We present a new derivation of multivariate Beveridge–Nelson permanent and transitory components, whereby the latter can be derived explicitly as a weighting of observable stationary processes. This allows far clearer economic interpretations. Different assumptions on the fundamental stationary processes result in distinctly different results, but this reflects deep economic uncertainty. We illustrate with an example using Garratt et al. 's (2003a) small VECM model of the UK economy. Copyright © 2006 John Wiley & Sons, Ltd.