Trends and cycles: How important are long- and short-run restictions? The case of Mexico

Abstract

The document presents a test for the existence of binding long- and short-run (common trend-common cycle) restrictions in the dynamics of a set of Mexican macroeconomic variables. These restrictions are imposed in a VAR to decompose the series into their permanent and transitory components. The analysis shows that the magnitude of transitory (nominal) shocks is underestimated when such restrictions are not considered. In addition, we find that the timing and duration of recession and expansion periods are more accurately estimated when the trend-cycle decomposition is conducted with the imposition of cointegrating (long-run) and common feature (short-run) restrictions.