1

Stylized Facts
Facts about the macroeconomy are drawn from national accounts and
other statistics.
Each entry in national accounts (GDP, consumption, GDP de ator) represents a time series:
2
3
y1
6 y2 7
6
7
7
fyt g = 6
6 y3 7
4 ::: 5
yT

Time series can be thought of as random variables. Observed variables are

the sample whose statistical properties can be used to infer the stochastic
properties of the larger population.
Time series are not statistically independent. They are likely to be correlated across time. Standard statistical techniques for dealing with nonindependent variables can be applied.
The statistical properties of an observed sample (for example in Hong
Kong real GDP between 1970:1 and 2001:3) only represent the underlying
distribution of the population if the underlying distribution is not changing
permanently over time. For many economic series, this cannot be true.
Observe that over time Hong Kong's GDP has been consistently growing
over time. If technology and productivity are always growing over time,
the underlying distribution of the level of Hong Kong's GDP is changing
over time.
Natural way to think about time series which is consistently changing
levels over time is to decompose the time series into two parts: trend
growth and cycles.
yt = T REN Dt + ybt

In this decomposition, the trend path represents the constant change in

the level of the series which is thought to be a deterministic function of
time. This function is usually represented as a polynomial in time (usually
a rst order polynomial).
T REN Dt = 0 + 1 t + 2 t2 + 3 t3 + :::::
The cycle term will represent a stochastic random variable whose underlying distribution does not permanently change. Such a random variable
is said to be stationary. The trend can be estimated with a least squares
regression of yt on time. The residual will be the cycle term.
1

 Macroeconomic theory also decomposes into two parts: theories of long

term growth and theories of business cycles. These will be thought of as
theoretical explanations for the trend and the cycle. Under this decomposition, the economy will experience consistent growth, the speed of which
needs to be explained. Further, random shocks will cause the economy to
be sometimes above and sometimes below its growth path.
This is not the only way to think about macroeconomic phenomenon. For
example, many theories have explained the cyclical component of business
cycles as deterministic processes. In other statistical models, the correlation of the time series over time is so great that any shocks have permanent
eects on the level of the series. For example, consider the model
yt = (1 ) + yt

t i::i:d:; E(t ) = 0; E(2t ) = 2

+ t ;

Consider the eect of a shock at time 0, 0 , on the series over time.

y0 = 0 ;

y1 = 0 ;

y2 = 2 0 ;

yt = t 0

If < 1; then limt!1 yt = 0. In this case, we can calculate the moments

of yt :
E (y) = (1 ) + E(y) =

(1 )
=
(1 )

V ar(y) = E[(y )2 ] = 2 E[(y )2 ] + 2 =

2
1 2

But if = 1, then limt!1 yt = 0 . Every shock has a permanent eect

on the level of y. This means the variable is not stationary. It also
means that the second moments of yt are not well de ned. Such a process
is sometimes referred to as a stochastic growth model (a more common
name is a random walk)
yt = yt

+ t

A natural way to convert a time series generated by a random walk into

a stationary variable is to rst dierence the series. The rst dierence
of a time series yt is just yt yt 1
yt . In the case of a random
walk, yt = t which is stationary. In such a stochastic process, the
decomposition between trend and cycle is not so neat. Further, many
economic time series will have extreme dependence such that even after
a deterministic trend is removed, th auto-correlation is near 1. In nitie
data, it is di cult to statistically decide whether economic variables are
trend or dierence stationary. Further, taking rst dierences removes a
lot of the information about the position of the economy.
Hodrick-Prescott Filter. One compromise is to construct a trend which
could be determinisitic or stochastic but in which the stationary term
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Variable
GDP
C
I
NX
Y/H
H

Standard Deviation
3.3%
3.6%
6.7%
2.2%
2.3%
1.6%

Correlation w/Output
1.00
0.67
0.63
-0.10
0.61
0.82

Table 1: Business Cycle Statistics

240000

200000

160000

120000

80000

40000
1975

1980

1985

1990

1995

2000

GDP

Figure 1:
retains a lot of information about the position of the economy. Choose
T REN Dt
min

T
T
X
X

(yt T REN Dt )2 +
(T REN Dt+1 T REN Dt ) (T REN Dt T REN Dt
t=1

t=1

Stylized Facts: Growth Rate of Output in Hong Kong about 1.5% per
quarter or 6% per year.
Business Cycle Volatility

1)

.2
.1
.0
-.1
300000

-.2

250000

-.3

200000
150000
100000
50000
0
1975

1980

1985

1990

GDP
Log-Linear Trend
Cycle

Figure 2:

1995

2000

.08
.04
.00
250000

-.04

200000

-.08

150000

-.12

100000
50000
0
1975

1980

1985

1990

1995

GDP
Hodrick Prescott Trend
Cycle

Figure 3:

2000