Permanent vs Transitory Components and Economic Fundamentals

Anthony Garratt (), Donald Robertson and Stephen Wright

No 501, Birkbeck Working Papers in Economics and Finance from Birkbeck, Department of Economics, Mathematics & Statistics

Abstract: 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. 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.

Keywords: Multivariate Beveridge-Nelson; VECM; Economic Fundamentals; Decomposition. (search for similar items in EconPapers)
JEL-codes: C1 C32 E0 E32 E37 (search for similar items in EconPapers)
Date: 2005-01
New Economics Papers: this item is included in nep-ets and nep-mac
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https://eprints.bbk.ac.uk/id/eprint/27049 First version, 2005 (application/pdf)

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Journal Article: Permanent vs transitory components and economic fundamentals (2006)
Journal Article: Permanent vs transitory components and economic fundamentals (2006)
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