Business cycle duration dependence and foreign recessions
| Author | Gabe Bondt,Philip Vermeulen |
| DOI | http://doi.org/10.1111/sjpe.12261 |
| Published date | 01 February 2021 |
| Date | 01 February 2021 |
Scott J Polit Econ . 2021;68:1–19. wileyonlinelibrary.com/journal/sjpe
|
1
© 2020 Scottis h Economic Societ y
I think it's a myt h that expansions die of old age…t he fact that this has bee n quite a long expansion
doesn’t lead me to b elieve that…its days are nu mbered.
(Janet Yellen, press conference, December 16, 2015)
1 | INTRODUCTION
The remark by Jane t Yellen epitomizes the conventional w isdom that US expansions are n ot duration dependent ,
that is, their pro bability of ending is un related to their duration . This is however somewhat at od ds with the ongo-
ing controversy in the literature. On the one hand, seminal studies by Diebold and Rudebusch (1990) and Sichel
(1991) did not find duration de pendence of post-World War (WW) I I US expansions. But on the oth er hand, later
studies by Zuehl ke (2003) and Lay ton and Smith (2 007) conclude d that US expansio ns show positive dur ation
Accepted: 7 July 2 020
DOI: 10 .1111/sjpe.1 2261
ORIGINAL ARTICLE
Business cycle duration dependence and foreign
recessions
Gabe de Bondt1 | Philip Vermeulen2
1Business Cycle A nalysis Division , European
Central Bank, Frankfurt am Main, Germany
2Faculty of Business, Economics and
Law, Auckland U niversity of Technolo gy,
Auckland, New Zealand
Correspondence
Philip Vermeul en, 120 Mayoral Drive 1010,
Auckland Central, Auckland 1010, New
Zealand.
Email: philip.vermeulen@aut.ac.nz
Abstract
This study revisit s business cycle duration d ependence in G7
countries by controllin g for foreign recessions, d efined as
the number of other G7 cou ntries in a recession. E stimates
from regime switching l ogit models show that th e monthly
likelihood of ending an ex pansion roughly doubles for ever y
extra G7 countr y in recession, but the end of foreign reces-
sions do not affect t he ending of recessions. They also show
that recessions are dur ation dependent in a ll G7 countries,
but expansions only in t he United States and Germany. The
economic impor tance of foreign recessio ns and duration in
driving business c ycle phase changes vary across countr ies.
KEYWORDS
duration dependence, recessions, regime switching logit model,
business cycles
JEL CLASSIFI CATION
E32; C41
2
|
DE BONDT aND VERMEULEN
dependence, that is, they are more likely to end as they become older. More recently, Rudebusch (2016) argues
against durat ion dependence in post-WW II ex pansions. Certain ly, the issue is not settled.
The debate is impo rtant as it relates to t wo opposing views ab out the nature of busine ss cycles. One view, with
a long history i n macroeconomics, is th at expansions bring fort h their own unsustainab le trends1 which gradually
build up vulner ability of the economy to s hocks or policy mist akes that bring an end to the e xpansion. If increase d
recession risk in deed accumulat es over time, one sho uld expect ex pansions to show posi tive duration de pen-
dence. Anothe r more modern view of business cyc les is that economies are hit by rand om shocks that are time
independent . A recession can occur any time but is not more likely as ti me progresses.2
Importan tly, much of the discussion on d uration depende nce has been confined to t he analysis of the dome stic
business cycle i n isolation. Thi s is surprising, as a l arge literature h as shown that busin ess cycles displ ay a large
degree of synch ronicity acro ss countries, in dicating the pr esence of what one c an call a world bus iness cycle
(Lumsdaine and P rasad, 2003, Kose et al . 2003, 2008). Th erefore, phase changes fr om expansion to recession a re
potentially ca used by spillovers from this world bu siness cycle. This seems reaso nable, as for instance evidenc e
by Castro (2010) show s that when the US economy reache s a peak, the likelihood of expa nsions ending in other
countries increases.
In this paper we ex tent the duration dependenc e literature by revis iting the ques tion of duration de pen-
dence conditio nal on the world bus iness cycle. Th e way we introduce the wo rld business c ycle respect s the
usual way in which th e duration depe ndence literat ure models the bu siness cycle an d phrases the du ration
dependence qu estion. In that liter ature, the business c ycle is traditionall y described as the out come of a binary
random variable
St
taking the val ue zero say in an expansion (
St=0
) and one in a recessi on (
St=1
). Duration
Dt
is simply the tim e spent in a parti cular phase. A for mal phrasing of th e duration depe ndence quest ion is
whether the fol lowing equality holds for a ll n:
P(St=j|St−1=j,Dt−1=n)=P(St=j|St−1=j)
. If the equalit y holds, the
likelihood of the cu rrent phase continuing is indep endent from it s length and he nce there is no dura tion de-
pendence.3 Following this fr amework, conditioni ng on the world business c ycle can be readily done a s follows.
First, add u p the cycles of the major countrie s driving the world business c ycle (for the purpose of this pape r
we use the G7 membe r countries) but exclude th e country whose dura tion dependence is bei ng tested (its own
business cycle p hase is conditioned on already s eparately). That is, sum the binar y outcome
St
across the G7
countries, excl uding the domestic co untry under invest igation. We denote this vari able as
RG7exk
t−1
. This proxy for
the world busine ss cycle is simply the numb er of foreign recessions and has a n umber of advantages. It c an be
constructe d on a monthly basis, is compatible w ith the way the busin ess cycle is defined in the durat ion de-
pendence liter ature and has an easy inter pretation. Impor tantly, this cumulated me asure of other G7 countrie s
in a recession allow s one to get a sense of the impact of ea ch additional foreign countr y in a recession on the
likelihood of the ending of an expansion. The duration dependence question becomes formally whether
P
(S
t
=j
|
S
t−1
=j,D
t−1
=n,R
G7exk
t−1
=z)=P(S
t
=j
|
S
t−1
=j,R
G7exk
t−1
=z
)
. In words, conditi onal on foreign rec essions (i.e. the
number of other G7 co untries facing a reces sion), does the length of t he current phase matter f or its likelihood
of continuing?
Independen t of the duration depend ence question, a sys tematic analysis of the ef fect of foreign reces sions on
the likelihood of b usiness cycle phase change s has been lacking in the dur ation dependence liter ature so far. Our
paper recti fies this. The f irst contribu tion is a systemat ic analysis of the ef fect of foreig n recessions on the
1For instanc e three such tren ds—rapidly ris ing real estat e values, growi ng current accou nt deficits an d increasing lev erage—have bee n linked to the
global fina ncial crisis and G reat Recessio n by Obstfeld an d Rogoff (2009) a nd many others.
2In the same pre ss conference Ja net Yellen, direc tly after st ating her disbe lief in positive d uration depen dence, prese nts this view: But the economy
does get hit by sh ocks, and ther e are both positive s hocks and nega tive shocks. An d so there is a signif icant odd, you k now, probabili ty in any year that th e
economy will su ffer some shoc k that we don’t know ab out that will put i t into recession (…) b ut it isn’t somethi ng that is fated to happ en because we’ve h ad a
long expansion.
3There is positive duration dependence of phase j if
P(St
=
j|St−1
=
j,Dt−1
=
n)
decreases when n increases. There is negative duration dependence if
the opposit e holds.
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