nep-sea New Economics Papers
on South East Asia
Issue of 2015‒07‒04
twenty-one papers chosen by
Kavita Iyengar
Asian Development Bank

  1. Global Liquidity, Capital Inflows and House Prices in ASEAN Economies By Matthew S. Yiu; Sahminan Sahminan
  3. Thailand Country Study ASEAN Economic Community Blueprint Mid-term Review Project By Saowaruj Rattanakhamfu; Sumet Ongkittikul; Nutthawut Laksanapunyakul; Nichamon Thongpat; Natcha O-Charoen
  4. Fiscal rules, growth and employment : a developing country perspective By Ray, Nikhil; Velasquez, Agustin; Islam, Iyanatul
  5. AEC Scorecard Phase IV: Furthering the Implementation of the AEC Blueprint Measures The Singapore Country Report By Hank LIM; Bernard AW; LOKE Hoe Yeong
  6. Evolving Informal Remittance Methods of Myanmar Migrant Workers in Thailand By Koji Kubo
  7. Macroprudential policy in a microprudential world By Williams, John C.
  8. Toward an Effective Regulatory Management System: Philippines By Llanto, Gilberto M.
  9. Rapid Appraisal of the Postharvest Facilities Projects in the Philippines By Manalili, Nerlita M.; Yaptenco, Kevin F.; Manilay, Alessandro A.
  10. Political economy of the Indonesian mass killing of 1965-1966 By Mushed, Syed Mansoob; Tadjoeddin, Mohammad Zulfan
  11. Dynamics of Growth, Poverty and Human Capital: Evidence from Indonesian Sub-National Data. By de Silva, Indunil; Sumarto, Sudarno
  13. Does Social Performance Drives Corporate Governance Mechanism in MFIs? An Issue of Endogeneity By Nawaz, Ahmad; Iqbal, Sana
  14. Loan-to-Value Policy as a Macroprudential Tool: The Case of Residential Mortgage Loans in Asia By Morgan, Peter; Regis, Paulo Jose; Salike, Nimesh
  15. Technological Progress with Segmented Factor Markets and Welfare Implications for the Urban Poor By Pedro M. G. Martins
  16. Role of the Central Bank in supporting economic diversification and productive employment in Cambodia By Khou, Vouthy; Cheng, Oudom; Leng, Soklong; Meng, Channarith
  17. Should investors diversify their portfolios with stocks from major trading countries? A comparative multivariate GARCH-DCC and wavelet correlation analysis By Dwihasri, Dhaifina; Masih, Mansur
  18. Inequality in emissions: Evidence from Indonesian households By Mohammad Iqbal Irfany
  19. Political Connections and Firm Value: Evidence from the Regression Discontinuity Design of Close Gubernatorial Elections By Quoc-Anh Do; Yen-Teik Lee; Bang Dang Nguyen
  20. Robust Forecast Comparison By Sainan Jin; Valentina Corradi; Norman Swanson
  21. Business Cycles, Trend Elimination, and the HP Filter By Peter C. B. Phillips; Sainan Jin

  1. By: Matthew S. Yiu (Hong Kong Monetary Authority and ASEAN+3 Macroeconomic Research Office); Sahminan Sahminan (Bank Indonesia and ASEAN+3 Macroeconomic Research Office)
    Abstract: Quantitative Easing (QE) policies, adopted by the advanced economies since 2009, have led to abundant global liquidity. In the same period, the ASEAN-5 economies (Indonesia, Malaysia, the Philippines, Singapore and Thailand) have recorded strong capital inflows, particularly portfolio inflows. Asset prices, in particular house prices in these economies, have also experienced excess buoyancy. This paper studies the relationship between global liquidity, house prices and capital flows. Empirically, capital inflows have had a positive effect on residential house prices in Indonesia, Malaysia, the Philippines and Singapore. After accounting for domestic demand (using real GDP growth as a proxy), capital inflows have still had a positive impact in Indonesia and Singapore. The authorities of these economies have implemented similar macroprudential measures to safeguard financial stability and reduce speculative activity. The effectiveness of the measures has been seen mainly through a reduction in housing transactions.
    Keywords: Capital Flows, Residential House Price, Macroprudential, ASEAN Economies
    JEL: E44 E58 G28 R31
    Date: 2015–06
    Abstract: Global Entrepreneurship and Development Index or the Global Entrepreneurship and Development Index (GEDI) In 2013 positioned Indonesia at ranked 76 of 118 countries. Compared with the ASEAN countries, the position are still far below Singapore (13), and still below Malaysia (57), Brunei Darussalam (58), Thailand (65). This fact shows that Indonesia has not been optimal in building its entrepreneurial yet. To enhance the development of entrepreneurship, the Indonesian government has launched a National Entrepreneurship Movement (GKN), with the aim to increase the number of Indonesia’s entrepreneurs, where now the number of entrepreneurs approximately 0.25% of the total population. In an effort to maintain and improve the position of entrepreneurship that has been achieved today, entrepreneurial practitioners should build sustainable entrepreneurship for creating a strong entrepreneurial competitiveness, sustainable and mutually supportive by involving the synergies of the various elements of society. With the creation of sustainable entrepreneurship, the competitiveness level can be realized nationally and globally. The sustainable entrepreneurship focuses on entrepreneurial skills to achieve the success through social and environmental change or social innovations. Entrepreneurship is not only generating economic success but also the entrepreneurs (sustainable entrepreneurs) should be able to manage the "triple bottom line" (company profitability, potential benefits to the environment, and potential benefits to the community) by balancing economic health, social equity and environmental sustainability through the entrepreneurial behaviors. Lately, a lot of scientific discussions concerning entrepreneurship theory and practice related to sustainable entrepreneurship in a goal-oriented society, ethics, economics, and ecology have bee done. Even some studies on sustainable entrepreneurship have been more developed compared with the business and environment studies, especially in matters of affecting changes in social practices and business environments. However, the question is "How do we understand the characteristics, motivation and factors driving sustainable ecopreneurs to innovate?" The next question is, "How can the implementation of sustainable entrepreneurship in Indonesia in order to be able to compete on a global level?". This paper aims to discuss the conceptual approach of sustainable entrepreneurship and to outline how sustainable entrepreneurs to innovate in bringing additional benefits for the community and the environment.
    Keywords: Keywords: sustainable entrepreneurship, competitiveness, social, global, environment.
    JEL: Q01
    Date: 2014–05–22
  3. By: Saowaruj Rattanakhamfu (Thailand Development Research Institute); Sumet Ongkittikul (Thailand Development Research Institute); Nutthawut Laksanapunyakul (Thailand Development Research Institute); Nichamon Thongpat (Thailand Development Research Institute); Natcha O-Charoen (Thailand Development Research Institute)
    Abstract: The main objectives of this study are to determine progress in the implementation of the key Association of Southeast Asian Nations (ASEAN) Economic Community (AEC) measures compared to the first monitoring effort in 2010–2011, and to compare the gap between the liberalisation rate in terms of commitments and in terms of actual policies. This study also examines the implementation bottlenecks and generates recommendations from stakeholders (such as the business sector, academia, and government) to address the key bottlenecks and move forward the implementation of the AEC measures into 2015 and beyond (2016–2025). In addition, in view of the importance of the private sector for the successful realisation and deepening of the AEC in 2015 and beyond, this study explores greater partnership with or engagement of the private sector by conducting both intensive consultations and interviews with key informants in the private sector. The AEC measures of interest in this study are services liberalisation, nontariff measures (NTM), trade facilitation, investment liberalisation, mutual recognition arrangements (MRA) on professional services, and standards and conformance.
    Keywords: Thailand, AEC, service liberalisation, non-tariff measure, trade facilitation, investment liberalisation, mutual recognition arrangements on professional services, standards and conformances
    JEL: F13 F15
    Date: 2015–06
  4. By: Ray, Nikhil; Velasquez, Agustin; Islam, Iyanatul
    Keywords: fiscal policy, fiscal law, economic growth, low income, case study, Brazil, Cameroon, Indonesia, developing countries, politique fiscale, droit fiscal, croissance économique, faible revenu, étude de cas, Brésil, Cameroun, Indonésie, pays en développement, política fiscal, derecho fiscal, crecimiento económico, bajos ingresos, estudio de casos, Brasil, Camerún, Indonesia, países en desarrollo
    Date: 2015
  5. By: Hank LIM (Singapore Institute of International Affairs); Bernard AW (Singapore Institute of International Affairs); LOKE Hoe Yeong (Singapore Institute of International Affairs)
    Abstract: Singapore is an open economy that is critically dependent on leveraging external resources to achieve its economic growth. To achieve that objective, the government is strongly committed to maintaining a free and competitive economy. In the case of service liberalisation, however, there are a number of restrictions on foreign labour in the service sectors under review that may have an adverse impact on the service sectors. Nonetheless, Singapore is ready to integrate fully into the Association of Southeast Asian Nations (ASEAN) Economic Community (AEC) with most of the service sectors meeting or exceeding the requirements set forth by ASEAN Member States (AMSs), even in the financial, banking, and telecommunication sectors. On Standards and Conformance, there has been some progress for the five sectors under review. However, the progress is described as slow due to sluggish process undertaken by other AMSs. Singapore’s approach is to adopt and directly use international standards and technical standards for most sectors, which puts it in a good position to align itself with the agreed ASEAN standards.. With regard to the five sectors under review, Singapore has transposed most ASEAN guidelines on Standards and Conformance into national legislation. A considerable progress has been observed in architectural and engineering services as the implementation mechanisms and processes at both regional and national levels have been established. Regarding this sector, Singapore has generally maintained a liberal immigration policy on professional mobility until recent years. In future, this liberal policy on professional mobility might be adjusted due to increasing domestic political pressure to restrict the inflow of foreign labour. While substantial progress has been made, there is still room to accelerate efforts towards regional integration and facilitation of professional service mobility by prioritisingand establishing a template for other designated professions. On Non-Tariff Measures (NTMs), Singapore is ranked highly as a liberalised trading economy, as there were no divergences between the agreed regulations on non-tariff measures and the actual practice in Singapore, nor is there any bottleneck in implementing non-tariff measures. There is a prevalent understanding and impression that the NTMs are centred on technical barriers to trade, rather than sanitary and phytosanitary measures or non-automatic licensing, quotas, prohibition. On the ASEAN Comprehensive Investment Agreement (ACIA), the Singapore government has been quite positive in its public statements. In drafting the Reservation List, the government looked to its existing national rules and regulations as its basis. As such, Singapore’s Exclusive List document extensively cited the sources of legislation.. It is noted in the study that Singapore does not experience any problems in implementing the ACIA agreement as its Reservation List is one of the shortest amongstthose submitted by AMSs.
    Keywords: services and investment liberalisation, non-tariff measures (NTM)
    JEL: F15
    Date: 2015–06
  6. By: Koji Kubo (Institute of Developing Economies, Japan External Trade Organization)
    Abstract: We shed light on diverse informal remittance methods of Myanmar migrant workers in Thailand. Based on the questionnaire survey of migrant workers, we examine the determinants in their choice of informal remittance methods. The empirical results indicate that the accessibility of payment points in Myanmar is an important determinant; migrants sending remittances to town can choose potentially more efficient operators who employ bank branches as payment points. On the assumption that informal operators’ use of bank branches stimulates competition among them, we argue that expanding branch network of Myanmar banks adds to efficiency of the informal remittance market.
    Keywords: migrant worker remittances, informal remittance methods, Myanmar
    JEL: E26 O16 O17
    Date: 2015–06
  7. By: Williams, John C. (Federal Reserve Bank of San Francisco)
    Abstract: Symposium on Asian Banking and Finance, Singapore, May 28, 2015
    Date: 2015–05–28
  8. By: Llanto, Gilberto M.
    Abstract: In the emerging ASEAN Economic Community, regulatory quality and coherence will be critical in stimulating investments and improving the overall business and investment climate. The different countries in the region are concerned not only with aligning and harmonizing regulatory frameworks, but also first and more fundamentally, with reducing regulatory burden, improving regulatory quality and coherence. To achieve these objectives, the literature suggests the establishment of an efficient and effective regulatory management system (RMS). An efficient and effective RMS will be a critical mechanism for "reducing the costs of doing business, facilitating international trade and investment, and improving regulatory outcomes in areas such as health, safety, and environmental protection." The paper examines the case for a regulatory management system for the Philippines and recommends specific measures for its establishment in Philippine policy space. It describes the overall experience of the country in regulatory reform, highlights the challenges in its journey toward regulatory quality and coherence, and identifies steps in constructing a responsive regulatory management system.
    Keywords: Philippines, regulation, regulatory quality, regulatory burden, regulatory management system, regulatory impact analysis, regulatory impact statement, cost of doing business
    Date: 2015
  9. By: Manalili, Nerlita M.; Yaptenco, Kevin F.; Manilay, Alessandro A.
    Abstract: The Philippine government's postharvest loss reduction programs entail significant investments (manpower, facilities, and equipment) and their impacts need evaluating. Thus, the Philippine Institute for Development Studies and the National Economic and Development Authority commissioned NEXUS Agribusiness Solutions to undertake the "Rapid Appraisal of Selected Postharvest Facilities in the Philippines". The postharvest facilities (PHF) selection process considered at least one each for Luzon, Visayas, and Mindanao, and for the following PHF categories: 1. equipment and facilities required immediately after harvest; 2. processing and storage facilities; and 3. market infrastructure and transport facilities. Selected were four rice processing centers, established through a Korean International Cooperation Agency grant, in Pangasinan, Davao del Sur, Bohol, and Iloilo. Using these sites as hub, other nearby PHF such as food terminals, flatbed dryers, and threshers were included for evaluation. In the context of upgrading value chains, reducing postharvest losses and improving economic outcomes for smallholder farmers, selected PHF were characterized and assessed. Recommendations centered on project management enhancement (timeliness of preparatory activities, participatory planning, etc.) and on operational improvements (capacity utilization, viability, and sustainability).
    Keywords: Philippines, postharvest loss, postharvest facility, value chain, agricultural marketing, rapid appraisal
    Date: 2015
  10. By: Mushed, Syed Mansoob; Tadjoeddin, Mohammad Zulfan
    Abstract: This chapter sketches the build up to the mass killing (politicide) of communists and communist sympathisers in Indonesia, during 1965 to 1966. Our key contribution is to explain why ordinary individuals, not belonging to the elite, might wish to participate in the act of murder. The mass murder aided the consolidation of the new order autocratic regime of Suharto, but his ascension to power cannot be separated from the cold war politics of the time. Over three decades of authoritarian rule did bring about broad based economic progress. In time, the authoritarian contract sustaining the regime became untenable and the contract lacked credible commitment in the absence of the transfer of some political power to the new middle class. This mirrors the modernization theory of endogenous democracy, which states that at higher level of income, the pressure for democracy becomes inexorable.
    Keywords: Indonesia, mass killing, politicide, communists
    JEL: N45
    Date: 2015–03
  11. By: de Silva, Indunil; Sumarto, Sudarno
    Abstract: The aim of this study is twofold. First, despite the vast empirical literature on testing the neoclassical model of economic growth using cross-country data, very few studies exist at the sub-national level. We attempt to fill this gap by utilizing panel data over the 2002-2012 period, a modified neoclassical growth equation, and a dynamic panel estimator to investigate the effect of both health and education capital on economic growth and poverty at the district level in Indonesia. Secondly, whilst most existing cross-country studies tend to concentrate only on education as a measure of human capital, we expand the analysis and probe the effects of health capital as well. As far as we are aware, no study has done a direct and comprehensive examination of the impacts of health on growth and poverty at the sub-national level. Thus this study is a premier at the sub-national level, and our findings will be particularly relevant in understanding the role of both health and education capital in accelerating growth and poverty reduction efforts.
    Keywords: Neoclassical Growth, Poverty, Human Capital, Health, Education, Dynamic Panel
    JEL: H7 I3 O4
    Date: 2014–01–16
  12. By: Hyungsun Chloe Cho; Miguel Ramirez (Department of Economics, Trinity College)
    Abstract: This paper examines the relationship between foreign direct investment (FDI) and income distribution in the host country as measured by the Gini coefficient. After providing some background and reviewing the extant literature, it undertakes a panel unit root and cointegration analysis that tests whether FDI has a non-linear impact on income inequality in seven selected Southeast Asian countries over the period 1990 to 2013. The paper finds strong evidence for panel cointegration using the Pedroni Augmented Dickey Fuller (ADF) and Phillips-Perron (PP) tests; thus, it proceeds to utilize the group-mean fully modified ordinary least squares (FMOLS) procedure to generate long-run estimates that are unbiased and consistent. The FMOLS estimator is also extremely accurate even in panels with very heterogeneous serial correlation dynamics, fixed effects, and endogenous regressors. The results confirm the hypothesis that FDI inflows tend to raise income inequality in the short run but reduce it in the long run. In this study, the Gini index starts decreasing after FDI inflows as a percentage of GDP reaches 0.56. The fact that the Gini coefficient reaches its maximum at a relatively low level of FDI inflows suggests that sample countries are endowed with substantial absorptive capacity. In other words, they will shift into the new technological paradigm quickly, thus supporting pro-globalization claims that, on balance, FDI is more beneficial than harmful.
    Keywords: Gini coefficient; Foreign direct investment (FDI); Fully modified ordinary least squares (FMOLS); Panel unit roots; Panel cointegration test; Southeast Asian countries
    JEL: C33 O10 O53
    Date: 2015–06
  13. By: Nawaz, Ahmad; Iqbal, Sana
    Abstract: Microfinance institutions of Asia work exclusively with the mission of social welfare hence play an important role in the economic and financial development of a region.Endogeneity poses a serious threat to the authenticity of corporate governance and performance studies because of the endogenous nature of many governance and performance variables. This paper addresses this issue in the context of microfinance sector in Asia by answering the question whether social performance determines the corporate governance mechanism of MFIs. Using a panel of 173 MFIs in 18 Asian countries for the period of five years, a comprehensive corporate governance index (CGI)based on of seven internal governance mechanism variables in constructed as an indicator of the overall corporate governance mechanism of MFIs. By employing GLS model, our results indicate insignificant impact of corporate governance on many social performance variables which are attributed to the endogenous nature of this relationship as the significance of results improved by studying relationship in reverse direction by employing ordered logit model. Our results indicate that social performance is an important determinant of corporate governance mechanism of MFIs even after controlling for MFI related characteristics.
    Keywords: Microfinance; Corporate Governance; Social performance; Endogeneity; Asia
    JEL: G21 G30 M14
    Date: 2015–02–08
  14. By: Morgan, Peter (Asian Development Bank Institute); Regis, Paulo Jose (Asian Development Bank Institute); Salike, Nimesh (Asian Development Bank Institute)
    Abstract: Credit creation in the housing market has been a key source of systemic financial risk, and therefore is at the center of the debate on macroprudential policies. The loan-to-value (LTV) ratio is a widely used macroprudential tool aimed at moderating mortgage loan creation, and its effectiveness needs to be estimated empirically. This paper is unique in that it analyzes the effect of LTV on mortgage lending, the direct channel of influence, using a large sample of banks in 10 Asian economies. It uses estimation techniques to deal with the large presence of outliers in the data. Robust-to-outlier estimations show that economies with LTV polices have expanded residential mortgage loans by 6.7% per year, while non-LTV economies have expanded by 14.6%, which suggests LTV policies have been effective.
    Keywords: loan-to-value policy; residential mortgage loans; macroprudential policy; financial risk
    JEL: C23 E58 G21 G28
    Date: 2015–06–24
  15. By: Pedro M. G. Martins
    Abstract: This paper provides a comprehensive assessment of structural change patterns in the world economy. It uses a new dataset on sectoral employment produced by the International Labour Organization, which is complemented by national accounts and population data from the United Nations Department of Economic and Social Affairs. The sample includes 169 countries, representing about 99 percent of the world's output and population in 2013. One of the main contributions of this paper is its focus on the sub-regional level, which has been hitherto absent from the literature. We provide an assessment of 13 sub-regions in Africa, Asia and Latin America in order to offer deeper and richer insights into the recent dynamics of structural change. Overall, our results suggest that within-sector productivity improvements were the key driver of output per capita growth in most sub-regions. Nonetheless, structural change has also played a critical role in enhancing economic performance since 2002 – mainly through services. Changes in the demographic structure and employment rates have also contributed to the recent performance, albeit to a much lesser extent. Accelerating the pace of structural change – by exploiting existing productivity gaps – will be crucial to sustain current economic growth rates in developing regions.
    Keywords: Structural change, labour productivity JEL Classifications: J20, O11, O40
  16. By: Khou, Vouthy; Cheng, Oudom; Leng, Soklong; Meng, Channarith
    Abstract: This study was undertaken by a team from the National Bank of Cambodia (NBC). It is a prime example of collaboration between a major national institution responsible for the conduct of monetary and financial policy and the ILO.
    Keywords: economic growth, bank, employment creation, Cambodia, croissance économique, banque, création d'emploi, Cambodge, crecimiento económico, banco, creación de empleos, Camboya
    Date: 2015
  17. By: Dwihasri, Dhaifina; Masih, Mansur
    Abstract: The existing literature have evaluated the performance of stock markets without taking into account the time-varying correlations and different investment horizons of the investors. The present paper attempts to investigate to what extent the Indonesian sharia stock returns can earn portfolio diversification benefits if they are trading with sharia stocks from its major trading partners (China, Japan, United States). The recent Multivariate GARCH Dynamic Conditional Correlation, the Continuous Wavelet Transform and the Maximal Overlap Discrete Wavelet are applied. Our findings tend to indicate that the Indonesian investors may not enjoy portfolio diversification benefits in all investment horizons if investing in China as better investment opportunities are available by investing in Japan and United States. However, in the long run all markets are highly correlated yielding minimal portfolio diversification benefits.
    Keywords: Islamic stocks, portfolio diversification, MGARCH-DCC, Wavelets
    JEL: C22 C58 G11
    Date: 2015–06–26
  18. By: Mohammad Iqbal Irfany (Georg-August-University Göttingen)
    Abstract: Although the literature on emission inequality is abundant, this study will differentiate itself by focusing on emission inequalities at the household level due to the disparity in household expenditure profiles. We further separate measures on emission inequality based on household characteristics as well as decompose it into sources of emission. Employing a common application for analyzing inequalities, results show that as per capita expenditure increases, within quintiles emission inequality tends to decline until the middle quintiles but then further increases in expenditure level and worsens emission inequality until the richest household. The decomposition of inequality based on emission sources suggests that energy-transportation dominantly contributes of the overall emission inequality.
    Keywords: carbon footprint; household; inequality
    JEL: O12 O13 D12 D63
    Date: 2015–06–25
  19. By: Quoc-Anh Do (Département d'économie); Yen-Teik Lee (Singapore Management University); Bang Dang Nguyen (University of Cambridge)
    Abstract: Using the regression discontinuity design of close gubernatorial elections in the U.S., we identify a significant and positive impact of the social networks of corporate directors and politicians on firm value. Firms connected to elected governors increase their value by 3.89%. Political connections are more valuable for firms connected to winning challengers, for smaller and financially dependent firms, in more corrupt states, in states of connected firms’ headquarters and operations, and in closer, smaller, and active networks. Post-election, firms connected to the winner receive significantly more state procurement contracts and invest more than do firms connected to the loser.
    Keywords: Close Gubernatorial Election; Corruption; Firm Value; Political Connection; Procurement; Regression Discontinuity Design; Social Nteworks
    JEL: D72 D73 G28 G30 G34 G38 H57
    Date: 2015–04
  20. By: Sainan Jin (Singapore Management University); Valentina Corradi (University of Surrey); Norman Swanson (Rutgers University)
    Abstract: Forecast accuracy is typically measured in terms of a given loss function. However, as a consequence of the use of misspecified models in multiple model comparisons, relative forecast rankings are loss function dependent. This paper addresses this issue by using a novel criterion for forecast evaluation which is based on the entire distribution of forecast errors. We introduce the concepts of general-loss (GL) forecast superiority and convex-loss (CL) forecast superiority, and we establish a mapping between GL (CL) superiority and first (second) order stochastic dominance. This allows us to develop a forecast evaluation procedure based on an out-of-sample generalization of the tests introduced by Linton, Maasoumi and Whang (2005). The asymptotic null distributions of our test statistics are nonstandard, and resampling procedures are used to obtain the critical values. Additionally, the tests are consistent and have nontrivial local power under a sequence of local alternatives. In addition to the stationary case, we outline theory extending our tests to the case of heterogeneity induced by distributional change over time. Monte Carlo simulations suggest that the tests perform reasonably well in finite samples; and an application to exchange rate data indicates that our tests can help identify superior forecasting models, regardless of loss function.
    Keywords: convex loss function, empirical processes, forecast superiority, general loss function
    JEL: C12 C22
    Date: 2015–05–13
  21. By: Peter C. B. Phillips (Cowles Foundation, Yale University); Sainan Jin (Singapore Management University)
    Abstract: We analyze trend elimination methods and business cycle estimation by data filtering of the type introduced by Whittaker (1923) and popularized in economics in a particular form by Hodrick and Prescott (1980/1997; HP). A limit theory is developed for the HP filter for various classes of stochastic trend, trend break, and trend stationary data. Properties of the filtered series are shown to depend closely on the choice of the smoothing parameter (lambda). For instance, when lambda = O(n^4) where n is the sample size, and the HP filter is applied to an I(1) process, the filter does not remove the stochastic trend in the limit as n approaches infinity. Instead, the filter produces a smoothed Gaussian limit process that is differentiable to the 4'th order. The residual 'cyclical' process has the random wandering non-differentiable characteristics of Brownian motion, thereby explaining the frequently observed 'spurious cycle' effect of the HP filter. On the other hand, when lambda = o(n), the filter reproduces the limit Brownian motion and eliminates the stochastic trend giving a zero 'cyclical' process. Simulations reveal that the lambda = O(n^4) limit theory provides a good approximation to the actual HP filter for sample sizes common in practical work. When it is used as a trend removal device, the HP filter therefore typically fails to eliminate stochastic trends, contrary to what is now standard belief in applied macroeconomics. The findings are related to recent public debates about the long run effects of the global financial crisis.
    Keywords: Detrending, Graduation, Hodrick Prescott filter, Integrated process, Limit theory, Smoothing, Trend break, Whittaker filter
    JEL: C32
    Date: 2015–06

This nep-sea issue is ©2015 by Kavita Iyengar. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.