Economic Growth and Business Cycles: A Critical Comment on Detrending Time Series

In this paper we pursue an approach based on economic theory to illustrate possible shortcomings of widely used detrending methods. We analyze a simple model of economic growth and business cycles in which investment and technical progress are stochastic. The Hodrick-Prescott and the Baxter-King filter are shown to detect spurious business cycles that are not related to actual cycles in the model. Our results cast doubts on the validity of commonly accepted stylized business cycle facts. We also discuss the relation of business cycle dating based on indicators of economic activity, as applied, for example, by the National Bureau of Economic Research, and the detrending results.