DP15758 Aggregate Output Measurements: A Common Trend Approach

Author(s):	Martin Almuzara, Gabriele Fiorentini, Enrique Sentana
Publication Date:	February 2021
Keyword(s):	cointegration, GDI, GDP, Overdifferencing, Signal Extraction
JEL(s):	C32, E01
Programme Areas:	Monetary Economics and Fluctuations
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=15758

We analyze a model for N different measurements of a persistent latent time series when measurement errors are mean-reverting, which implies a common trend among measurements. We study the consequences of overdifferencing, finding potentially large biases in maximum likelihood estimators of the dynamics parameters and reductions in the precision of smoothed estimates of the latent variable, especially for multiperiod objects such as quinquennial growth rates. We also develop an R2 measure of common trend observability that determines the severity of misspecification. Finally, we apply our framework to US quarterly data on GDP and GDI, obtaining an improved aggregate output measure.