Permanent and Transitory Components of European Business Cycle

In this paper, we have estimated a model that incorporates two key features of business cycles, co-movement among economic variables and switching between regimes of expansion and recession, to aggregate quarterly data for the former Europe countries in the OECD. Two common factors, interpreted as reflecting the permanent and transitory components of the business cycle in the region, and estimates of turning points from one regime to the other were extracted from the data by using the Kalman filter and maximum likelihood estimation approach of Kim (1994). Estimation results confirm a fairly typical stylized fact of business cycles - recessions are steeper and shorter than recoveries, and both comovement and regime switching are found to be important features of the business cycle in the region. The two common factors produce sensible representations of the trend and cycle, and the estimated turning points agree quite well with independently determined chronologies.