Output Fluctuations in the G-7: An Unobserved Components Approach

This paper contributes to the debate about the relative importance of permanent versus transitory disturbances as sources of variation in output across the G-7 countries. We employ a multivariate unobserved components model to simultaneously decompose the real GDP for each of the G-7 countries into their respective permanent and transitory components. In contrast to much of the related literature, our model allows for explicit interaction between the components both within and across series. This approach thus allows us to distinguish cross-country correlations driven by the relationships between permanent innovations from those between transitory movements. We find that fluctuations in output are primarily due to permanent movements for all of the G-7 countries. We also find that the correlation between the permanent and transitory innovations within each series is significantly negative. With regards to cross- country relationships, we find important idiosyncratic variation in the correlation across different country pairs.