Measuring business cycles with structural breaks and outliers: Applications to international data

• We apply the trend-cycle decomposition method proposed by Perron and Wada (Journal of Monetary Economics, 2009) to the G7 countries’ output and consumption data.
• With the Mixtures of Normals decomposition, we assess puzzles in international business cycles, especially the consumption-correlation puzzle.
• We also examine whether business cycles exhibit the so-called Great Moderation.
• We find that international business cycles are not very puzzling, and that there is little evidence for the Great Moderation.

This paper first generalizes the trend-cycle decomposition framework of Perron and Wada (2009) based on unobserved components models with innovations having a mixture of normals distribution, which is able to handle sudden level and slope changes to the trend function as well as outliers. We investigate how important are the differences in the implied trend and cycle compared to the popular decomposition based on the Hodrick and Prescott (HP) (1997) filter. Our results show important qualitative and quantitative differences in the implied cycles for both real GDP and consumption series for the G7 countries. Most of the differences can be ascribed to the fact that the HP filter does not handle well slope changes, level shifts and outliers, while our method does so. Then, we reassess how such different cycles affect some so-called “stylized facts” about the relative variability of consumption and output across countries.