Detrending, Stylized Facts and The Business Cycle (Now published in Journal of Applied Econometrics, vol.8 (1993), pp.231-247.)
Andrew C Harvey and Albert Jaeger
The stylized facts of macroeconomic time series can be presented by fitting structural time series models. Within this framework, we analyze the consequences of the widely used detrending technique popularized by Hodrick and Prescott (1980). It is shown that mechanical detrending based on the Hodrick-Prescott fitter can lead investigators to report spurious cyclical behaviour; and this point is illustrated with empirical examples. Structural time series models also allow investigators to deal explicitly with seasonal and irregular movements which may distort estimated cyclical components. Finally, the structural framework provides a basis for exposing the limitations of ARIMA methodology and models based on a deterministic trend with a single break.