Stochastic Trends and Economic Fluctuations

Recent developments in macroeconomic theory emphasize that transient economic fluctuations can arise as responses to changes in long run factors -- in particular, technological improvements -- rather than short run factors. This contrasts with the view that short run fluctuations and shifts in long run trends are largely unrelated. We examine empirically the effect of shifts in stochastic trends that are common to several macroeconomic series. Using a linear time series model related to a VAR, we consider first a system with GNP, consumption and investment with a single common stochastic trend; we then examine this system augmented by money and prices and an additional stochastic trend. Our results suggest that movements in the "real" stochastic trend account for one-half to two-thirds of the variation in postwar U.S. GNP.