Reconciling output gaps: Unobserved components model and Hodrick–Prescott filter

Angelia Grant and Joshua Chan

Journal of Economic Dynamics and Control, 2017, vol. 75, issue C, 114-121

Abstract: This paper reconciles two widely used trend–cycle decompositions of GDP that give markedly different estimates: the correlated unobserved components model yields output gaps that are small in amplitude, whereas the Hodrick–Prescott (HP) filter generates large and persistent cycles. By embedding the HP filter in an unobserved components model, we show that this difference arises due to differences in the way the stochastic trend is modeled. Moreover, the HP filter implies that the cyclical components are serially independent—an assumption that is decidedly rejected by the data. By relaxing this restrictive assumption, the augmented HP filter provides comparable model fit relative to the standard correlated unobserved components model.

Keywords: Trend–cycle decomposition; HP filter; Structural break (search for similar items in EconPapers)
JEL-codes: C11 C52 E32 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (31)

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Working Paper: Reconciling output gaps: unobserved components model and Hodrick-Prescott filter (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:75:y:2017:i:c:p:114-121

DOI: 10.1016/j.jedc.2016.12.004

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