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#pe****t >* UBRAfflBS) & l Jo ^VV Vk <^> Digitized by the Internet Archive in 2011 with funding from Boston Library Consortium Member Libraries http://www.archive.org/details/asymmetricbusineOOacem DEWEY )i HB31 .M415 ! working paper department of economics ASYMMETRIC BUSINESS CYCLES: THEORYAND TIME-SERIES EVIDENCE Daron Acemoglu Andrew Scott 95-24 Aug. 1995 massachusetts institute of technology 50 memorial drive Cambridge, mass. 02139 ASYMMETRIC BUSINESS CYCLES: THEORYAND TIME-SERIES EVIDENCE Daron Acemoglu Andrew Scott 95-24 Aug. 1995 MASSACHUSETTSINSTITUTE , --.•ogy NOV 1 4 1995 95-24 ASYMMETRIC BUSINESS CYCLES: THEORY AND TIME-SERIES EVIDENCE Daron Acemoglu Department of Economics Massachusetts Institute of Technology and Andrew Scott Institute of Economics and Statistics and AH Souls College, Oxford University August 1995 JEL Classification: E32 Keywords: Asymmetries, Cyclical Indicator, Intertemporal Increasing Returns Regime Shifts, Temporal Agglomeration, Unobserved Components. Abstract We offer a theory ofeconomic fluctuations based on intertemporal increasing returns: agents who have been active in the past face lower costs of action today. This specification explains the observed persistence in individual and aggregate output fluctuations even in the presence of i.i.d shocks, essentially because individuals respond to the same shock differently depending on their A recent past experience. feature of our model is that output growth follows an unobserved components process with special emphasis on an underlying cyclical indicator. The exactprocess for output, the sharpness ofturning points and the degree of asymmetry are determined by the form that We heterogeneity takes. suggesta general formulation formodels with latentcyclical variables which, under certain assumptions, reduces to a number of state space models that have been successfully used to model U.S. GNP. Using ourgeneral formulation we findthat allowing forricherheterogeneity enables us to obtain a better fit to the data and also that U.S. business cycles are asymmetric, with this asymmetry manifesting itself as steep declines into recession. We estimate a strongly persistent cyclical component which is not well approximated by discrete regime shifts nor by linear models. Our estimates of the relative size of intertemporal returns needed to explain U.S. GNP vary but on the whole are not implausibly large. WeoweaspecialdebttoJames Hamiltonwhoseinsightfulcomments improvedanearlierversionofthispaper.Wealsothank Philippe Aghion, Charlie Bean, Ricardo Caballero, Paul David, Steve Durlauf, Vittorio Grilli, Christopher Harris, Rebecca Henderson, Per Krusell, Jim Malcomson, John Moore, Chris Pissarides, Danny Quah, Kevin Roberts, Donald Robertson, variousseminarparticipantsandtwoanonymousrefereesforusefulcomments.Remainingerrorsaretheauthors' responsibility.