Why Are the Beveridge-Nelson and Unobserved-Components Decompositions of GDP So Different?

James Morley, Charles Nelson and Eric Zivot
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Eric Zivot: University of Washington

The Review of Economics and Statistics, 2003, vol. 85, issue 2, 235-243

Abstract: This paper reconciles two widely used decompositions of GDP into trend and cycle that yield starkly different results. The Beveridge-Nelson (BN) decomposition implies that a stochastic trend accounts for most of the variation in output, whereas the unobserved-components (UC) implies cyclical variation is dominant. Which is correct has broad implications for the relative importance of real versus nominal shocks. We show the difference arises from the restriction imposed in UC that trend and cycle innovations are uncorrelated. When this restriction is relaxed, the UC decomposition is identical to the BN decomposition. Furthermore, the zero-correlation restriction can be rejected for U.S. quarterly GDP, with the estimated correlation being -0.9. © 2003 President and Fellows of Harvard College and the Massachusetts Institute of Technology.

Date: 2003
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Related works:
Working Paper: Why are Beveridge-Nelson and Unobserved-component decompositions of GDP so Different? (2003)
Working Paper: Why Are Beveridge-Nelson and Unobserved-Component Decompositions of GDP So Different? (2002)
Working Paper: Why are Beveridge-Nelson and Unobserved-Component Decompositions of GDP so Different? (2000)
Working Paper: Why Are Beveridge-Nelson and Unobserved-Component Decompositions of GDP So Different? (2000)
Working Paper: Why Are Beveridge-Nelson and Unobserved-Component Decompositions of GDP So Different? (2000)
Software Item: RATS programs to replicate Morley-Nelson-Zivot state space decomposition
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