Markov-Switching Models with Evolving Regime-Specific Parameters: Are Post-War Booms or Recessions All Alike?

Yunjong Eo and Chang-Jin Kim ()

No 2012-04, Working Papers from University of Sydney, School of Economics

Abstract: In this paper, we relax the assumption of constant regime-specific mean growth rates in Hamilton's (1989) two-state Markov-switching model of the business cycle. We first present a benchmark model, in which each regime-specific mean growth rate evolves according to a random walk process over different episodes of booms or recessions. We then present a model with vector error correction dynamics for the regime-specific mean growth rates, by deriving and imposing a condition for the existence of a long-run equilibrium growth rate for real output. In the Bayesian Markov Chain Monte Carlo (MCMC) approach developed in this paper, the counterfactual priors, as well as the hierarchical priors for the regime-specific parameters, play critical roles. By applying the proposed approach to postwar U.S. real GDP growth (1947:Q4-2011:Q3), we uncover the evolving nature of the regime-specific mean growth rates of real output in the U.S. business cycle. An additional feature of the postwar U.S. business cycle that we uncover is a steady decline in the long-run equilibrium output growth. The decline started in the 1950s and ended in the 2000s. Our empirical results also provide partial, if not decisive, evidence that the central bank may have been more successful in restoring the economy back to its long-run equilibrium growth path after unusually severe recessions than after unusually good booms.

Keywords: State- Space Model; MCM; Hamilton Model; Markov Switching; Hierarchical Prior; Evolving Regime- Specific Parameters; Counterfactual Prior; Business Cycle; Bayesian Approach (search for similar items in EconPapers)
Date: 2012-02
New Economics Papers: this item is included in nep-cba, nep-ecm, nep-ets, nep-fdg, nep-mac and nep-ore
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Citations: View citations in EconPapers (9)

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Journal Article: Markov-Switching Models with Evolving Regime-Specific Parameters: Are Postwar Booms or Recessions All Alike? (2016)
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