Predicting Ordinary And Severe Recessions With A Three State Markov Switching Dynamic Factor Model An Application To The German Business Cycle
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Predicting Ordinary and Severe Recessions with a Three-State Markov-Switching Dynamic Factor Model. An Application to the German Business Cycle
Author | : Kai Carstensen |
Publisher | : |
Total Pages | : 43 |
Release | : 2017 |
Genre | : |
ISBN | : |
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We estimate a Markow-switching dynamic factor model with three states based on six leading business cycle indicators for Germany preselected from a broader set using the Elastic Net soft-thresholding rule. The three states represent expansions, normal recessions and severe recessions. We show that a two-state model is not sensitive enough to reliably detect relatively mild recessions when the Great Recession of 2008/2009 is included in the sample. Adding a third state helps to clearly distinguish normal and severe recessions, so that the model identifies reliably all business cycle turning points in our sample. In a real-time exercise the model detects recessions timely. Combining the estimated factor and the recession probabilities with a simple GDP forecasting model yields an accurate nowcast for the steepest decline in GDP in 2009Q1 and a correct prediction of the timing of the Great Recession and its recovery one quarter in advance.
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