DO PERMANENT SHOCKS EXPLAIN INCOME LEVELS? A COMMON CYCLE–COMMON TREND ANALYSIS OF REGIONAL INCOME LEVELS FOR CHINA

Abstract. In this paper, we analyse per capita income levels of China's three main regions: the western region, the eastern region and the central region using common cycle and common trend tests. Our main contribution is that we impose the common cycle and common trend restrictions in decomposing shocks into permanent and transitory components. We find that: (i) there is evidence for two cointegrating relationships and one common cycle; and (ii) the variance decomposition analysis of shocks provides evidence that over short horizons, permanent shocks play a large role in explaining variations in regional per capita incomes.     

Did monetary or technology shocks move euro area stock prices?

Using a Bayesian vector autoregressive (VAR) model, I investigate the impact of monetary and technology shocks on the euro area stock market. I find an important role for technology surprise shocks, but not monetary shocks, in explaining variations in real stock prices. Specifically, the pronounced boom?Cbust cycle of 1995?C2003 is largely due to technology surprise shocks. The identification method allows me to study the effects of technology news shocks. The responses are consistent with the idea that news on technology improvements has an immediate impact on stock prices. These findings are robust to several modelling choices, including the productivity measure, the specification of the VAR model, and the identifying restrictions.     

Trends and Cycles in Australian State and Territory Unemployment Rates

In this paper we test for the presence of common trends and cycles in the state unemployment rates, and examine the relative dispersion of unemployment rates across the states and their relationship with the business cycle. Importantly, the results suggest that, contrary to widely held opinion, there is a case for regional unemployment policy (i.e. policy of a kind that discriminates between states and territories) in Australia. In particular: in the case of Tasmania and the two territories, regional policy is needed to counter both temporary and permanent shocks; and in the case of the mainland states – and especially mainland states with above-average unemployment rates – regional policy is needed to counter permanent shocks but not temporary shocks.     

Common Trends and Common Cycles in Per Capita GDP: The Case of the G7 Countries, 1870–2001

In this paper we analyze per capita incomes of the G7 countries using the common cycles test developed by Vahid and Engle (Journal of Applied Econometrics, 8:341–360, 1993) and extended by Hecq et al. (Oxford Bulletin of Economics and Statistics, 62:511–532, 2000; Econometric Reviews, 21:273–307, 2002) and the common trend test developed by Johansen (Journal of Economic Dynamics and Control, 12:231–254, 1988). Our main contribution is that we impose the common cycle and common trend restrictions in decomposing the innovations into permanent and transitory components. Our main finding is permanent shocks explain the bulk of the variations in incomes for the G7 countries over short time horizons, and is in sharp contrast to the bulk of the recent literature. We attribute this to the greater forecasting accuracy achieved, which we later confirm through performing a post sample forecasting exercise, from the variance decomposition analysis.

Bilateral Tax Treaties and GDP Comovement

Using a 30‐year panel of quarterly gross domestic product (GDP) fluctuations from of a broad set of countries, we demonstrate that the signing of a bilateral tax treaty increases the comovement of treaty partners' business cycles by half a standard deviation. This effect of fiscal policy is as large as the effect of trade linkages on comovement and stronger than the effects of several other common financial and investment linkages. We also show that bilateral tax treaties increase comovement in shocks to nations' GDP trends, demonstrating the permanent effects of coordination on fiscal policy rules. We estimate trend and business cycle components of nations' output series using an unobserved‐components model in order to measure comovement between countries and then estimate the impact of tax treaties using generalized estimating equations.     

Further on the Nature of the Australian Business Cycle

Strong and Tan (1991) found Australian output variation was well characterized by a stochastic trend implying output shocks have a permanent effect on the level of activity. The paper finds that in Australia the stochastic trend alternative is statistically dominated when the data are allowed to be characterized by a probabilistic segmented trend specification. This finding implies shocks will only have a permanent effect on output when the series' growth path switches from one growth regime into another as a result of the shock.     

THE ROLE OF TECHNOLOGY AND NONTECHNOLOGY SHOCKS IN BUSINESS CYCLES*

This article proposes a method to identify technology and nontechnology shocks that permanently affect labor productivity and applies this method to data for the G7 countries. In most cases, whereas technology improvements have negative or weak effects on hours worked, positive permanent nontechnology shocks are expansionary. Permanent nontechnology shocks play an important role in business cycles, particularly in the United States and Japan, and account for 71% of a large reduction in Japan's detrended output from 1991 to 2002. Credit conditions are likely to be an important driver of variations in permanent nontechnology shocks.     

Common trends and common cycles in regional crime

This paper uses the Vahid and Engle (Journal of Applied Econometrics, 8, 341-360, 1993) common trend - common cycle approach to model the dynamics of regional crime rates in England over the period 1975–1996. The evidence indicates the existence of common trends and common cycles in regional crime rates. This result is exploited to examine the system-wide effects of shocks emanating in a particular region.     

Corporate credit,stock price inflation and economic fluctuations

This study analyses the empirical interaction between real corporate credit, real income, real stock prices, the short-term interest rate and inflation for the Netherlands and the USA. The framework is based on a five-variable structural vector error correction model which identifies the permanent and temporary shocks within the system. Erratic shocks in the real amount of corporate credit and in stock prices could potentially have some impact on inflation in the case of the USA and on real output in the Netherlands. However, the structural VAR analysis also shows that the above-mentioned erratic shocks only explain a small proportion of the variation in inflation and economic activity, and inflation objective shifts and supply side shocks are much more important determinants for economic fluctuations.     

Permanent shocks and forecasting with moving averages

Moving averages are a common method of forecasting futures basis. We argue that the optimal lengths of moving averages depend on the frequency of structural breaks. A new stochastic time-series process including structural breaks is modelled by discrete probability distributions that capture the frequency and size of structural breaks. A permanent shock (means structural breaks in this article) is captured by a Poisson-jump or a Bernoulli-jump process, and a temporary shock is represented by a white noise process. Futures basis data are used to estimate the frequency of permanent shocks as well as the size of both shocks. Most shocks are permanent shocks. Since most shocks are permanent, the most recent year provides the best forecast and the optimal length of the moving average is one.     

Emerging economy business cycles: Interest rate shocks vs trend shocks

The recent literature studying the source of business cycles in emerging market economies (EMEs) has debated the relative importance of productivity trend shocks versus interest rate shocks coupled with financial frictions. The studies in which an important role is assigned to interest rate shocks do not force their models to match the historical paths of the world or country interest rate. We show that this leads to poorly identified interest rate shocks and inaccurate measures of contributions of shocks to EME business cycles. To address this issue, we estimate a small open economy model for Argentina and Mexico using Bayesian methods where the world and country interest rate series in the model are forced to match their data counterparts. This estimation strategy results in larger variations in interest rate shock and, therefore, shifts explanatory power away from trend shocks towards interest rate shocks, although both shocks remain important.     

International stock markets comovements: the role of economic and financial integration

The contribution of economic and financial integration to international stock markets comovements are investigated by means of a large scale macroeconometric model, set in the factor vector autoregressive framework (F-VAR). The findings point to a relevant role for both economic and financial integration in explaining international stock markets comovements for the G-7 countries. While economic integration would exercise its effects through the common response of stock markets to global economic shocks, financial integration would operate through financial shocks spillovers, particularly at the regional level.      

Revisiting the relationship between exchange rates and fundamentals

In this paper, we apply the permanent–transitory decomposition method to analyze the role of permanent and transitory shocks in explaining the apparent weak link between nominal exchange rates and economic fundamentals. The results suggest that for most of the countries we investigate, including Finland, Italy, Portugal, France and Switzerland, transitory shocks dominate exchange rate fluctuations, while permanent shocks dominate the variations in economic fundamentals. The findings therefore provide an alternative interpretation of the “exchange rate disconnect puzzle”. Moreover, the results also suggest that comprehensive modeling of transitory components in empirical models should not be neglected in studies of the dynamics of exchange rates.     

Oil shocks,US economic uncertainty,and emerging stock markets

This paper investigates the impacts of oil price shocks and US economic uncertainty on emerging equity markets within a structural VAR model. I find that both precautionary oil demand and US economic uncertainty shocks have significant negative effects on emerging stock returns, whereas aggregate demand shocks cause a sustained rise of the returns. In particular, the direct effects of oil shocks on emerging stock returns are amplified by the endogenous response of US economic uncertainty. Variance decomposition analysis shows that oil market fundamentals and US economic uncertainty are an important determinant of emerging equity returns, accounting for 35% and 24% of their long-term variations, respectively. The heterogeneous impacts of structural shocks on individual emerging markets, however, suggest that a well-diversified portfolio can be obtainable.     

Macroeconomic shocks and stock market returns: the case of Korea

This study examines the effects of macroeconomic shocks on key macro variables, including stock market returns in Korea, using the structural vector autoregression (SVAR) model. We suggest a three-variable SVAR model incorporating inflation, output growth and stock returns. We adopt a nonzero z-ratio restriction for the long-run identifying assumption to allow for economically meaningful relationships among variables. While our results support the negative (positive) relation of demand (supply) shocks to stock returns, we also find that demand shocks influence stock market variance more significantly than supply shocks do. The sub-period analysis finds that global market fluctuations during the global financial crisis have relatively little effect on Korean stock market performance. We also examine a generalized five-variable model that includes the foreign exchange rate and interest rate, confirming the results from the three-variable case.     

Dynamic common factors in large cross-sections

This paper develops a method to analyze large cross-sections with non-trivial time dimension. The method (i) identifies the number of common shocks in a factor analytic model; (ii) estimates the unobserved common dynamic component; (iii) shows how to test for fundamentalness of the common shocks; (iv) quantifies positive and negative comovements at each frequency. We illustrate how the proposed techniques can be used for analyzing features of the business cycle and economic growth.     

Do news shocks increase capital utilization?

Using the workweek of capital as a measure of capital utilization, we empirically test whether news shocks actually increase capital utilization. To this end, by estimating a panel VAR on two-digit manufacturing data identifying news shocks as innovations to stock returns orthogonal to the variations in current-period TFP growth, we find the positive response of capital utilization to news shocks. Moreover, to explain the positive response of capital utilization to news shocks in terms of plant-level investment behavior, we propose a heterogeneous plant model that combines the fixed cost of capital adjustment and an endogenous capital utilization choice. With the presence of fixed costs, except for the plants that have recently adjusted capital stock, news shock shortens the effective time horizon of currently installed capital stock and increases capital utilization. When the model economy is calibrated to match the salient features of the plant-level investment rate distribution, the economy generates a news-driven positive response of capital utilization.     

How do great shocks influence the correlation between oil and international stock markets?

We investigate the impacts of great shocks (2003 Iraq War and 2008 Financial Crisis) on the correlations between oil and US/China stock markets, utilizing a novel MADCC (mixed asymmetry dynamic conditional correlation) model. This model successfully captures the coexistence of opposite signed asymmetries. We find that great shocks indeed increased the correlations. Further, results from the news impact surfaces indicate that correlations between oil and stock markets are higher to joint negative shocks; however, correlation between stock markets has stronger response to joint positive shocks.     

The HUMP-shaped behavior of macroeconomic fluctuations

We analyze the nature of persistence in macroeconomic fluctuations. The current view is that shocks to macroeconomic variables (in particular realGNP) have effects that endure over an indefinite horizon. This conclusion is drawn from the presence of a unit root in the univariate time series representation. Following Perron (1989), we challenge this assessment arguing that most macroeconomic variables are better construed as stationary fluctuations around a breaking trend function. The trend function is linear in time except for a sudden change in its intercept in 1929 (The Great Crash) and a change in slope after 1973 (following the oil price shock). Using a measure of persistence suggested by Cochrane (1988) we find that shocks have small permanent effects, if any. To analyze the effects of shocks at finite horizon, we select a member of theARMA(p, q) class applied to the appropriately detrended series. For the majority of the variables analyzed the implied weights of the moving-average representation have the once familiar humped shape.     

Dissecting Exchange Rates and Fundamentals in the Modern Floating Era: The Role of Permanent and Transitory Shocks

In this paper, we apply a permanent–transitory decomposition method to analyze the link between nominal exchange rates and fundamentals in the modern floating era. The results suggest that transitory shocks dominate nominal exchange rate fluctuations, while permanent shocks dominate the variations in fundamentals. Therefore, the findings suggest that the nominal exchange rate should not be approximated by a pure random walk. Moreover, we find that unobserved fundamentals in the Taylor rule model can explain the transitory components in exchange rates.