Marcelle Chauvet and Chengxuan Yu
Economic Review, Vol. 91, No. 1, 2006
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The progressive globalization of markets has sparked a worldwide interest in using economic indicators to analyze cyclical fluctuations. Governments and the private sector seeking to conduct their activities in light of both national and international economic conditions could benefit from international indicators that serve as a warning system to detect recessions in major economic partners and in industrialized countries as a whole.
This article constructs just such a warning system. Using a Markov-switching dynamic factor model with a self-adjusting variable-bandwidth filter, the authors construct business cycle indicators for G7 countries and for an aggregate measure of output by twenty-nine member countries of the Organisation for Economic Co-operation and Development (OECD). The model yields probabilities of the current business cycle phase for each G7 country and for the aggregate OECD and G7 output measures and reveals a common cycle underlying the OECD countries that characterizes an international business cycle.
The proposed filter sorts out minor contractions and estimates only major economic recessions and expansions, thereby minimizing the occurrence of false turning points. This quality is especially important for central banks that may want to adjust monetary policy only in the event of major recessions affecting a broad set of economic sectors.
April 2006