Lagged GNP growth rates are poor forecasts of future GNP growth rates in
postwar US data, leading to the impression that GNP is nearly a random walk.
However, other variables, and especially the lagged consumption/GNP ratio, do
forecast long-horizon GNP growth, and show that GNP has temporary components.
Labor income and stock prices (using the dividend/price ratio) display the
same behavior. This paper documents these facts and examines their
implications for the persistence of shocks to GNP and time-variation in
expected stock returns. I find that GNP has an almost entirely transitory
response to a GNP shock that holds consumption constant. This is intuitive:
if consumption does not change, permanent income did not change, so the
change in GNP should be transitory. Similarly, a stock price shock that
holds dividends constant suggests a discount rate change, and prices display
a large transitory movement in response to this shock. The paper also
examines implications of transitory variations in GNP and labor income for
methods of extracting stochastic trends or "cyclically adjusting" GNP, and
for explaining "excess smoothness" violations of the permanent income
hypothesis.
*Published:
"Permanent and Transitory Components of GNP and Stock Prices," Quarterly Journal of Economics, pp. 241-265 (February 1994).
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