Business Cycle Dating after the Great Moderation: A Consistent Two – Stage Maximum Likelihood Method

Gilbert Mbara

No 2017-13, Working Papers from Faculty of Economic Sciences, University of Warsaw

Abstract: The two-state Markov switching model of dating recessions breaks down when confronted with the low volatility macroeconomic time series of the post 1984 Great Moderation era. In this paper, I present a new model specification and a two--stage maximum likelihood estimation procedure that can account for the lower volatility and persistence of macroeconomic times series after 1984, while preserving the economically interpretable two--state boom--bust business cycle switching. I first demonstrate the poor finite sample properties (bias and inconsistency) of standard models then suggest a new specification and estimation procedure that resolves these issues. The suggested likelihood profiling method achieves consistent estimation of unconditional variances across volatility regimes while resolving the poor performance of models with multiple lag structures in dating business cycle turning points. Based on this novel model specification and estimation, I find that the nature of US business cycles has changed: economic growth has permanently become lower while booms last longer than before. The length and size of recessions however remain unchanged.

Keywords: Regime Switching; Hidden Markov Models; Great Moderation; Maximum Likelihood Estimation (search for similar items in EconPapers)
JEL-codes: C32 C5 C51 C58 E32 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2017
New Economics Papers: this item is included in nep-bec, nep-ecm, nep-mac and nep-ore
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Persistent link: https://EconPapers.repec.org/RePEc:war:wpaper:2017-13

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