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The Relationship Between Permanent and Transitory Components of Recession

In this paper we investigate the contemporaneous and lead-lag relationship between two types of U.S. business cycle asymmetry pointed out in the literature: Infrequent large negative shocks that have permanent effects, modeled as shifts in the growth rate of trend from boom to recession and infrequent large negative shocks having only transitory effects, modeled as peak-reverting deviations from trend. We incorporate both types of asymmetry into a model of real GNP and consumption in which consumption anchors the trend. We find that a model that allows for the trend and transitory type asymmetry to be correlated is preferred to a model that assumes independence. In particular, the parameter estimates suggest a specific pattern of recessions: Shifts in trend growth rate lead both the appearance of large negative shocks to the transitory component when entering recessions and their disappearance when leaving recessions.