THE RELATIVE IMPORTANCE OF PERMANENT AND TRANSITORY COMPONENTS - IDENTIFICATION AND SOME THEORETICAL BOUNDS

Much macroeconometric discussion has recently emphasized the economic significance of the size of the permanent component in GNP. Consequently, a large literature has developed that tries to estimate this magnitude-measured, essentially, as the spectral density of increments in GNP at frequency zero. This paper shows that unless the permanent component is a random walk this attention has been misplaced: in general, that quantity does not identify the magnitude of the permanent component. Further, by developing bounds on reasonable measures of this magnitude, the paper shows that a random walk specification is biased towards establishing the permanent component as important.