‘Detrend’ and build your own story

Recently Steve Williamson made use of the H-P Filter to raise doubts about NGDP targeting. This generated a lively debate on ‘detrending’ so as to arrive at a stationary process amenable to statistical analysis. Tim Duy, David Glasner, Paul Krugman and I butted in.

After reading John Quiggin´s “Zombie Economics”, in particular chapter I “The Great Moderation”, in which he argues that it may be a myth, I decided to do some more illustrations. The results are charted below.

Leaving aside the ‘Bouncing 50s’, the successful policies of President Kennedy´s CEA, first chaired by Walter Heller and having people like James Tobin and Arthur Okun (Paul Samuelson was an outside advisor), took RGDP back to trend by 1965. The faith in ‘fine-tuning’ – the ironing-out of even minor fluctuations – ended up leading them to keep nominal spending (NGDP) growing on a rising trend. Rising inflation was the outcome, leading to “The Great Inflation” (“G.I.”). (Notice RGDP is systematically above trend)

After the “Volcker Transition” (“V.T.”), the economy entered the “Great Moderation”, a period marked by a large decrease in both nominal and real output volatility. (Notice that RGDP ‘hugs’ the trend during most of this time). Also, during this period NGDP follows a stable trend growth path.

Interesting to note that from the stock market´s point of view, the “Great Moderation” ‘ended’ in 1999, just as the Bush Jr. Administration came to power (PK will like that!).

Also of interest is the fact that – using the stock market ‘dating’ – the G.M. ended just as it was ‘discovered’ (meaning when the first papers about it were published). And lastly we have the ‘Bernanke Depression’ (‘D.P.’) where volatilities shoot up and the stock market plunges.

But you can try to build your own story from the illustrations!

7 thoughts on “‘Detrend’ and build your own story

  1. Excellent blogging of late–not of late, but as always.

    Thank goodness for Marcus Nunes and other Market Monetarist bloggers. Otherwise I would have thought myself alone in this world (intellectually speaking).

  2. Hi Marcus,

    This is a good post. A few comments:
    (1) I would recommend that you use the real, and not nominal, Dow Jones index given the period of time displayed.
    (2) If there was a Great Moderation — and my reading of your argument is that there was — then arguably it should show up in more than just NGDP/RGDP. What if one took all the standard macro data sets (nonfarm payrolls, various measures of inflation, etc.) and took the sum of their variance…That way one could compute a “volatility index” which would be more reflective (or not) of a Great Moderation.
    (3) I’m curious to know the mean volatility during each of the periods as you have broken them. You could do that by putting a horizontal line at that level on the graph.

    • Evan – Tks. The major change in the Dow chart would be, instead of a “flat table” during the GI a falling index. But agree, next time will put real version.
      The mean RGDPgrowth vols for each of the 6 periods in the chart are: 2.2, 1.1. 1.3, 1.9, 0.6, 1.3

  3. Hi, Marcus.
    The US economy got into trouble in the 1970s, with inflation and all. It is said the 1970s brought the death of Keynesian economics. By the 1980s we had new policy in place. On your first graph, the red trend line seems to be based on the combined economic performance of “before 1980” and “after 1980”. Your choice of this trend betrays certain assumptions in your work.

    Base your trend on RGDP through 1980, or through 1973 maybe, rather than on the whole period. The 1950s will not be bouncing and low, but bouncing and high. The slowdown will seem to begin around 1967.

    Or replace your straight-line trend (implying a constant growth rate on a log scale graph) with an decelerating trend; This trend line will fit RGDP much better.

    A decelerating trend says “things are getting worse”.


    • Art – It´s more or less recognized that US RGDP is trend stationary (maybe that´s changed now!), with real growth averaging about 3.3% from the early 50s to 2007. Given that empirical ‘fact’, what I did was regress the log of RGDP on a constant and trend up to 1997 and project to 2012.
      I start the period in 1952 to avoid the post war adjustment which distorts the data. For example, in 1950 real growth was 13.4%! For the rest of the 1950s, real growth averaged 3.1% with a very high s.d. (3.3) which compares to an average growth of 3.2% and s.d. of 1.5.from 1984 to 2007.

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