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Leigh Caldwell has a very nice and simple post about some of the theory on whether or not we should expect a unit root: http://www.knowingandmaking.com/2009/03/recession-and-recovery-krugman-and.html

Some dumb questions:
1. "There is a unit root" means that *at least part* of the recession is permanent. Yes? (It doesn't mean *all* of the recession is permanent, no?)
2. If only a very small part were permanent, it would be almost impossible to find it econometrically, unless you had a very large sample (which we don't). Yes?
3. Would it make sense to run a horse race between two hypotheses: "It's all permanent" vs. "It's all temporary"?

1. Having a unit root means that that one component of the series is a random walk, where all innovation are permanent.
2. That's another way of looking at the results. The unit root really only matters in the very long run, and we (usually) don't have that kind of data.
3. That 'horse race' is what Figure 1 is graphing.


A couple of questions:

(1) So in a world without unit roots, as your research indicates is the case, the big policy implication is that business cycles are largely about countercyclical management of aggregate demand, right? Similarly, a trend stationary world also means there are no cases where the natural rate of unemployment has changed due to some permanent innovation/structural shock, correct? If so, these are huge policy implications. Everyone taking a stand either way on the stimulus packages is implicitly assuming a trend-stationary or difference stationary world, correct?

(2) Menzie Chinn's long run graph of log GDP from the 1860s to the present is amazing. He reports formal tests showing trend stationarity, but the eyeball test itself is fascinating as you see this persistent trend for 150 years. If indeed the US GDP is on this trend stationary process what explains it? It is remarkable to me that the US so closely follows the trend all these years. But is the US really bound to it? Are there reasons why we would expect this relationship to hold up?

Stephen, you said: "Having a unit root means that that one component of the series is a random walk, where all innovation are permanent." Doesn't any causal model still have a white noise component? I assume you mean that having a unit root means that THE ONLY (important) component is the random walk, right?

I think it's just silly to suggest that economic growth is independent from year to year.

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