Nominal Stylized Facts of U.S. Business Cycles

Article excerpt

This paper investigates the basic nominal stylized facts of business cycles in the United States using monthly data from 1960:1 to 1993:4 and the methodology suggested by Kydland and Prescott (1990). Comparisons are made among simple-sum and Divisia aggregates using the Thornton and Yue (1992) series of Divisia monetary aggregates. The robustness of the results to (relevant) nonstochastic stationarity-inducing transformations is also investigated.

Kydland and Prescott (1990) argue that business cycle research took a wrong turn when researchers abandoned the effort to account for the cyclical behavior of aggregate data following Koopmans's (1947) criticism of the methodology developed by Burns and Mitchell (1946) as being "measurement without theory." Crediting Lucas (1977) with reviving interest in business cycle research, Kydland and Prescott initiated a line of research that builds on the growth theory literature. Part of it involves an effort to assemble business cycle facts. This boils down to investigating whether deviations of macroeconomic aggregates from their trends are correlated with the cycle, and if so, at what leads and lags.

Kydland and Prescott (1990) report some original evidence for the U.S. economy and conclude that several accepted nominal facts, such as the procyclical movements of money and prices, appear to be business cycle myths. In contrast to conventional wisdom, they argue that the price level (whether measured by the implicit GNP deflator or by the consumer price index), is countercyclical. Although the monetary base and M1 are both procyclical, neither leads the cycle. This evidence counters Mankiw's (1989) criticism of real business cycle models on the grounds that they do not predict procyclical variation in prices. Moreover, the evidence of countercyclical price behavior has been confirmed by Cooley and Ohanian (1991), Backus and Kehoe (1992), Smith (1992), and Chadha and Prasad (1994).

The cyclical behavior of money and prices has important implications for the sources of business cycles and therefore for discriminating among competing models. Initially it was argued, for example, that procyclical prices will be consistent with demand-driven models of the cycle, whereas countercyclical prices would be consistent with predictions of supply-determined models, including real business cycle models. Subsequently, however, Hall (1995) has shown that adding more detail to traditional demand-driven models can produce countercyclical prices, whereas Gavin and Kydland (1995) have shown that alternative money supply rules can generate either procyclical or countercyclical prices in a real business cycle setting.

The objective of this paper is to re-examine the cyclical behavior of money and prices using monthly U.S. data. For comparison purposes, the methodology used is mainly that of Kydland and Prescott (1990). Therefore in accordance with the real business cycle approach to economic fluctuations, we define the growth of a variable as its smoothed trend and the cycle components of a variable as the deviation of the actual values of the variable from the smoothed trend. However, we investigate robustness of the results to alternative (relevant) nonstochastic stationarity-inducing transformations.

To highlight the influence of money measurement on statistical inference [as in Belongia (1996)], comparisons are made among simple-sum and Divisia monetary aggregates (of M1A, M1, M2, M3, and L) - see Barnett, Fisher, and Serletis (1992) regarding the state of the art in monetary aggregation. The money measures employed are monthly simple-sum and Divisia indexes (from 1960:1 to 1993:4), as described in Thornton and Yue (1992), and were obtained from the Federal Reserve Economic Data (FRED) bulletin board of the Federal Reserve Bank of St. Louis.

The paper is organized as follows. Section 1 briefly discusses the Hodrick Prescott (HP) filtering procedure for decomposing time series into long-run and business cycle components. …