Page - 38 - in The Austrian Business Cycle in the European Context

38 called local linear trend where the level as well as the slope is rep- resented by stochastic processes. Depending on restrictions of the variance of these shocks, deterministic as well as random walks (with or without drift) and smoothly evolving trends can result63. This flexibility makes it difficult to judge the appropriateness of unob- served components models for business cycle analysis. In some more simple specifications they come close to the Beveridge- Nelson decomposition method. Morley - Nelson - Zivot (2002) argue that in the unobserved com- ponents framework the common (but not necessary) restriction that trend and cycle are uncorrelated leads to great differences in the cyclical output. Whereas the Beveridge-Nelson decomposi- tion implies that a stochastic trend accounts for most of the varia- tion in output, the cyclical variation is dominant in unobserved components models for their part. Lifting the restriction of trend and cycle being uncorrelated, the two approaches can yield identical decompositions. As Blanchard - Quah ( 1989) assigned supply shocks to the trend and demand shocks to the cycle, the assumption of uncorrelatedness in isolating the cycle can have decisively different consequences for economic policy. A possible advantage of modelling explicitly all components - as it is done in the unobserved components approach - is that this process can bear closer relation to economic theory than me- chanical filtering procedures do. Whereas the purely statistical non-parametric procedures of detrending can be accused of practicing "measurement without theory", Canova ( 1998) accuses all economic-theory-based decompositions as, "at best, attempts to approximate unknown features of a series and therefore sub- ject to specification errors". So, the explicit modelling strategy not only allows capturing theoretical aspects, but also contains sev- eral subjective assumptions. 63 Koopman et al. (2000) give an overview over how certain combinations of these restrictions affect the trend.