Charles L. Evans,
Daniel G. Sullivan,
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William A. Testa,
and Economics Editor
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Rita Molloy and Julia Baker,
Sheila A. Mangler,
Editorial Assistant.Chicago Fed Letter
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4. Estimates of the trend rate of economic growth
The figure displays estimates of the time-varying mean of real gross domestic product(GDP) growth based on the three variants of the DF-CFNAI (see the text for details on OLS,HR, and AR) from 1967:Q1 through 2012:Q4. For comparison, the Congressional BudgetOffice’s (CBO) estimate of growth in potential real GDP for the U.S. is also presented.
Authors’ calculations based on data from Haver Analytics.
percent growth on an annualized basis
1967 ’72 ’77 ’82 ’87 ’92 ’97 2002 ’07 ’121.02.03.04.05.0ARHROLSCBO
values (shown in fgure ), this suggestsreal GDP growth that is even urtherabove average. How do we reconcile this with the act that real GDP growth hasbeen much weaker on average during therecent recovery than during the recov-eries rom previous deep recessions? Oneinterpretation is that average (or trend)real GDP growth is now much lower andhas been declining during the recovery.Our alternative estimation rameworkmakes it possible to quantiy this possibility by decomposing real GDP growth intoits cyclical and trend components in theprocess o estimating the DF-CFNAI. Todo so, we use a “nowcasting” equation(similar to the one used in Brave andButters, 00), which relates current quarter real GDP growth to current andpast values o the three-month movingaverage o the DF-CFNAI. In this way, we both control or the cyclical dynamicso real GDP growth using the DF-CFNAIand allow current quarter real GDPgrowth to shape the DF-CFNAI’s recent history. Here, however, to capture thetrend component we also include a time- varying mean or real GDP growth, whichdistinguishes this exercise rom Braveand Butters (00) where we insteadconsidered several discrete shits in themean o real GDP growth over time.
We use the DF-CFNAI to control orthe cyclical component o real GDPgrowth because, likethe CFNAI, it can beshown to be an excel-lent coincident indi-cator o the businesscycle. Using the meth-od developed by Bergeand Jordà
to quantiy the accuracy o ourindexes in capturingU.S. recessions andexpansions since 967, we fnd that the HR and AR variants o the DF-CFNAI are both95% accurate, whilethe OLS variant andCFNAI are 94% accu-rate. So, by this mea-sure, the HR and AR variants o theDF-CFNAI are only slightly more accurate in identiying U.S.recessions and expansions than the OLS variant and the CFNAI, with the dier-ence not being statistically signifcant.Figure presents root mean squarederror (RMSE) ratios computed usingcurrent quarter orecasts o real GDPgrowth based on the CFNAI and thethree variants o the DF-CFNAI. For theCFNAI’s orecasts, we allow or discreteshits in the mean o real GDP growthover time as in Brave and Butters (00).In contrast, the DF-CFNAI’s orecastsare based on a time-varying mean orreal GDP growth. A value less than onein fgure indicates in each instancethat the DF-CFNAI’s orecasts are moreaccurate than the CFNAI’s (more pre-cisely, the lower the value, the moreaccurate the DF-CFNAI’s orecasts).
There is some variation in the level o accuracy across the DF-CFNAI variants’orecasts depending on the time period.In general, the OLS variant’s orecastsdominate those o the other two. Morerecently, however, the HR and AR models have produced slightly superiororecasts, but not enough to be statisti-cally signifcantly dierent rom theOLS model’s.Figure 4 plots the history o our esti-mates o the time-varying mean o realGDP growth based on the DF-CFNAIover the period 967:Q–0:Q4. Forcomparison, we also include in fgure 4the Congressional Budget Ofce’s (CBO)estimate o growth in potential real GDP.The CBO’s estimate o potential real GDPgrowth is calculated in a vastly dierent way than our estimate o the time-varyingmean o real GDP growth, but it too aimsto capture a similar notion o the long-run growth trend.
Our HR and AR esti-mates o the time-varying mean o realGDP growth are highly correlated withthe CBO’s estimate o potential growthand have an average absolute deviationo 0. percentage points rom it in thepost-984 era. That said, all our esti-mates have very dierent interpretationso recent history. The HR and AR growthestimates exhibit declines o about 0.5 per-centage points and 0.7 percentage pointssince 007, respectively; and the OLSgrowth estimate ell by roughly 0. per-centage points since then, while the CBO’sestimate o potential growth decreasedby 0.6 percentage points.
Our estimates o the trend rate o eco-nomic growth show that it has uctuatedconsiderably over time, alling romaround 4.5% in 967:Q to .5%–.5%by the end o 007. Its urther decline