Postwar U.S. Business Cycles: An Empirical Investigation

By Hodrick, Robert J.; Prescott, Edward C. | Journal of Money, Credit & Banking, February 1997 | Go to article overview

Postwar U.S. Business Cycles: An Empirical Investigation


Hodrick, Robert J., Prescott, Edward C., Journal of Money, Credit & Banking


We propose a procedure for representing a time series as the sum of

a smoothly varying trend component and a cyclical component. We

document the nature of the comovements of the cyclical

components of a variety of macroeconomic time series. We find

that these comovements are very different than the corresponding

comovements of the slowly varying trend components.

The purpose of this article is to document some features of aggregate economic fluctuations sometimes referred to as business cycles. The investigation Uses quarterly data from the postwar U.S. economy. The fluctuations studied are those that are too rapid to be accounted for by slowly changing demographic and technological factors and changes in the stocks of capital that produce secular growth in output per capita.

As Lucas (1981) has emphasized, aggregate economic variables in capitalist economics experience repeated fluctuations about their long-term growth paths. Prior to Keynes' General Theory, the study of these rapid fluctuations, combined with the attempt to reconcile the observations with an equilibrium theory, was regarded as the main outstanding challenge of economic research. Although the Keynesian Revolution redirected effort away from this question to the one of determining the level of output at a point in time in disequilibrium, the failure of the Keynesian Theory in the 1970s has caused many economists to want to return to the study of business cycles as equilibrium phenomena. In their search for an equilibrium model of the business cycle, modern economists have been guided by the insights of Mitchell (1913) and others who have used techniques of analysis that were developed prior to the development of modern computers. The thesis of this paper is that the search for an equilibrium model of the business cycle is only beginning and that studying the comovements of aggregate economic variables using an efficient, easily replicable technique that incorporates our prior knowledge about the economy will provide insights into the features of the economy that an equilibrium theory should incorporate.

This study should be viewed as documenting some systematic deviations from the restrictions upon observations implied by neoclassical growth theory.(1) Our statistical approach does not utilize standard time series analysis. Our prior knowledge concerning the processes generating the data is not of the variety that permits us to specify a probability model as required for application of that analysis. We proceed in a more cautious manner that requires only prior knowledge that can be supported by economic theory. The maintained hypothesis, based upon growth theory considerations, is that the growth component of aggregate economic time series varies smoothly over time. The sense in which it varies smoothly is made explicit in section 1.

We find that the nature of the comovements of the cyclical components of macroeconomic time series are very different from the comovements of the slowly varying components of the corresponding variables. Growth is characterized by roughly proportional growth in (per capita) output, investment, consumption, capital stock and productivity (output per hour), and little change in the hours of employment per capita or household. In contrast, the cyclical variations in output arise principally as the result of changes in cyclical hours of employment and not as the result of changes in cyclical productivity or capital stocks. In the case of the cyclical capital stocks in both durable and nondurable manufacturing industries, the correlation with cyclical output is even negative. Another difference is in the variability of components of aggregate demand. Cyclical consumption varies only one-half and investment three times as much as does cyclical output.

Section 2 presents our findings regarding the comovements of these series with the cyclical component of real GNP, as well as an examination of the cyclical components of prices, interest rates, and nominal and real money balances.

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