Applied Economics

ISSN: 0003-6846 (Print) 1466-4283 (Online) Journal homepage: http://www.tandfonline.com/loi/raec20

A new approach to dating and predicting

Australian business cycle phase changes

Allan P. Layton

To cite this article: Allan P. Layton (1997) A new approach to dating and predicting
Australian business cycle phase changes, Applied Economics, 29:7, 861-868, DOI:
10.1080/000368497326516

To link to this article: http://dx.doi.org/10.1080/000368497326516

Published online: 04 Oct 2010.

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 Applied Economics, 1997, 29, 861Ð 868

A new approach to dating and predicting

Australian business cycle phase changes
AL L A N P . L A Y T O N
School of Economics and Finance, QU T , GPO Box 2434 , Brisbane, Australia

Due to well-known lags, counter-cyclical macroeconomic policies often exacerbate,

rather than ameliorate, business cycles. Early recognition of upcoming phase shifts,
particularly contractions, may assist in ® ne-tuning such policies. This objective is
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pursued in the paper by applying Hamilton’s (1989, 1990, 1991) quasi-Bayesian,

Markovian, regime-switching model to monthly growth rates of leading, long -leading
and coincident indexes of Australian economic activity. A simple rule applied to
regime probabilities for each data point of the coincident index produces a phase
chronology that is very similar to that produced by the Bry and Boschan (1971)
turning point algorithm. The regime switching model is also applied to the leading
and long-leading indexes. The application of a simple rule to the resultant regime
probabilities is found to result in a potentially very reliable advance signalling system
for Australian business cycle phase changes.

I. INTRODUCTION business cycle developments in a number of countries in-

In an in¯ uential article, Hamilton (1989) developed a simple
Markov-based, regime switching model suitable for applica-
tion to time series subject to abrupt, non-linear regime
changes. He applied a two-state version of his model to
quarterly US GNP data and found the algorithm’s esti-
mated parameters broadly reproduced the characteristics of
the business cycle. The resulting series of regime probabilit-
ies produced a chronology that was quite similar to the
o cially recognized business cycle dates.
Layton (1994) applied the algorithm to Australian GDP
data and found the Australian business cycle could be
adequately characterized by long periods of normal average
growth, infrequently interrupted by short periods of abnor-
mally sluggish average growth. This is a somewhat di€ erent
characterization of the business cycle to the stochastic trend
alternative introduced by Nelson and Plosser (1982) and
Campbell and Mankiw (1987). The current paper extends
this earlier work and investigates the usefulness of Hamil-
ton’s framework in dating and predicting phase changes in
Australia’s business cycle within the context of the economic
indicator approach to business cycle modelling, pioneered
by Burns and Mitchell (1946) and Moore (1983).
In this regard the Centre for International Business
Cycle Research (CIBCR) at Columbia University monitors
0003Ð 6846 Ó 1997 Routledge
cluding Australia. It does this by maintaining systems of
leading, long-leading and coincident indexes of monthly
economic activity for each country. In fact, the leading and
coincident indexes maintained by the Institute of Applied
Economic and Social Research (IAESR) at Melbourne Uni-
versity are the result of joint research between IAESR and
CIBCR.
Components of Australia’s indexes are presented in
Table 1. Using the coincident index as an overall repres-
entation of the current phase of the business cycle yields an
Australian business cycle chronology (peak and trough
dates of aggregate economic activity) as presented in
Table 2. These are somewhat di€ erent from Australia’s o -
cial chronology which is based purely on using the occur-
rence of two consecutive negative (positive) quarterly
growth rates in GDP to signify the commencement of con-
traction (expansion). Apart from the fact that the index is
monthly, and therefore more timely, simply using GDP
amounts to solely using an output measure to represent the
business cycle. This is a rather narrow measure of the cycle
and ignores very important aspects of cyclical swings, name-
ly employment, sales and income.
These latter aggregates do not necessarily have exactly
the same phase chronology as output but, nonetheless, are
crucial aspects of the timing of any contraction or recovery.
861
 862 A. P. L ayton
Table 1. Index components

Coincident Leading Long-leading

Household income (real) Overtime worked Yields on 10 year treasury bonds

Gross non-farm product (real)
Industrial production
Retail trade (real)
Civilian employment
Unemployment rate (inverted)
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(inverted)
Housing approvals (No.) Housing approvals (No.)
Non-residential building approved
(constant price $) Gross product per hour (growth rate)
Money supply, M3 Money supply, M3
Industrial materials prices Services CPI Index
(growth rate, inverted)
Gross operating surplus of companies Ratio, implicit price de¯ ator to unit
labour cost, non-farm sector
Ratio, implicit price de¯ ator to unit
labour cost, non-farm sector
All ordinaries share price index
New telephone installations

Table 2. Australia’s business cycle chronology

Chronology using HMRS Extra phase changes

Coincident index chronology algorithm2 detected by HMRS

Peaks Troughs Peaks Troughs Peaks Troughs

4/51 8/52 4/51 9/52 1 /57 12/57

12/55 8/56 12/55 8/56 8/71 1/72
12/60 9/61 12/60 9/61 6/86 11/86
7/74 3/75 6/74 Missed
9/76 11/77 Missed 11/77
9/81 5/83 9/81 5/83
4/90 6/92 4/90 12/92

Median: Expansion = 49 months

Contraction = 14 months
1 By BryÐ Boschan turning point method.
2 HamiltonÐ Markov regime switching algorithm using COP (5) (see text).

For example, unemployment is known to lag output, both
going into, as well as coming out of contraction. Thus the
`o cial’ recovery date of the most recent contraction has
been set at the September quarter, 1991, because this was
the ® rst of two consecutive quarters of positive growth after
the onset of the contraction in March 1990. However, the
ensuing `recovery’ is well-known to have been very anaemic,
producing very little employment growth, and was therefore
associated with rising unemployment rates for several sub-
sequent quarters. The behaviour of the coincident index
re¯ ects this and produces a trough date of 6/1992, almost
a year later.
The coincident index chronology presented in Table 2 is
that obtained by CIBCR using the BryÐ Boschan (1971)
Turning point (BB) program to establish the dates of phase
changes. The BB method has been the `industry standard’
for obtaining turning points and is used by the US Com-
merce Department as well as by CIBCR. One problem with
the BB program is that it can take quite some time to
recognize a phase change once it has occurred. In fact the
BB program was written so that no turn would be identi® ed
within six months of the end of the data. Furthermore,
CIBCR sta€ advise it can sometimes take as long as 12
months for a turn to be identi® ed by the BB program.
The ® rst major purpose of the paper is therefore to
determine the potential for using a version of Hamilton’s
regime-switching algorithm to pick the monthly dates of
phase changes and to examine the speed with which the
algorithm would be able to recognize phase changes as they
occur in `real time’. As a ® rst step, the degree of correspond-
ence between the BB phase change dates and those gener-
ated by the regime-switching algorithm is established using
 Dating and predicting Australian business cycle phase changes
the entire sample of data (through to the end of 1994) to
establish the chronology.
The results are presented in Table 2 and, as can be seen,
the correspondence is quite encouraging. Given the very
di€ erent approaches used, the degree of correspondence
tends to con® rm strongly the BB-identi® ed phase change
dates. Variations between the two chronologies are dis-
cussed further in Section 3 after an outline of the regime-
switching algorithm and the BryÐ Boschan method is pre-
sented in Section 2.
Of great practical importance is the potential of the
regime-switching algorithm to predict phase changes in
advance of their occurrence. This potential, using Austra-
lia’s leading and long-leading indexes, is reported upon in
section 4 of the paper. Section 5 contains the conclusions of
the paper.
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II. THE REGIME SWITCHING MODEL AND
BRYÐ BOSCHAN METHOD
In a series of important papers, Hamilton (1989, 1990, 1991)
elaborated upon theoretical aspects of his Markovian, re-
gime switching modelling approach and demonstrated its
use in a number of applications. In simple terms a time
series is conceived of being in one of a number of di€ erent
states or regimes. The likelihood of observing various values
of the series then depends upon the particular regime in
which the series is, along with a speci® ed probability rule
associated with that regime.
In the context of the business cycle it is natural to
dichotomize between two regimes, namely contractions and
expansions in economic activity. For each regime the
simplest probability rule to govern the likelihood of various
observations is the normal density function with a di€ erent
mean and variance for contractions and expansions. Hamil-
ton also suggested the use of a Markov-type probability rule
to govern the likelihood of switching from one regime into
the other. The simplest such rule is that the switching
probability depends only on the current period regime
(rather than several earlier periods), and remains constant
regardless of the length of time the series has been in
a particular regime. This is the speci® c regime switching
model employed throughout this paper and can be repre-
sented as follows.
Let Y t and St denote the growth rate and regime state in
period t.
Then
3 1
1 - 1 Yt-
f (Y t /S t = i) =
exp
Ï 2p s i
2 s
1
The priors were computed as follows. Prior means and variances were set equal to the sample means and variances of the negative growth
rate observations (for regime 1) and positive growth rate observations (for regime 2).
863
where i = 1, 2 and 1 denotes contraction; and
P (S t = 1/St ± 1 = 1) = p P (St = 1/St ± 1 = 2) = 1 - q
P (S t = 2/St ± = 1) = 1 - p P (St = 2/St ± = 2) = q
1 1
To obtain estimates of the parameter vector (u1 , u2 , s 1 , s 2 , p,
q), maximum likelihood estimation (MLE) is used. As out-
lined by Hamilton (1990) the estimation algorithm may be
explained heuristically as follows. Suppose we had, through-
out the length of the sample, perfect knowledge of the
pattern of regimes characterizing the series. MLE estimates
of a particular regime mean and variance would simply be
obtained as the sample mean and variance of the series’
values corresponding to those periods when the series was
in that regime. MLE estimates of the two transition prob-
abilities (p, q) would simply be obtained from frequency
counts of the pattern of known regime switches.
This process e€ ectively applies probability weights of one
and zero to each value of the series (depending on the regime
in which one is interested). The same procedure could,
however, be used in the absence of perfect knowledge if one,
nonetheless, had estimates of the regime probabilities at-
taching to each data point. These estimated probabilities
could then be used as weights instead of the ones and zeros.
The estimation algorithm derives initial estimates of these
regime probabilities and uses them to obtain estimates of
the model’s parameters. These parameter estimates are then
used to update the estimates of the regime probabilities
which are, in turn, used to update the estimates of the model
parameters. The process continues in an iterative way until
the likelihood of the observed sample has been maximized
(subject to some speci® ed stopping rule).
Because of the assumed model structure, a potential es-
timation problem exists which may be described as follows.
Suppose, in practice, a small subset of sample observations
happens to be very tightly clustered together. Unrestricted
MLE may result in this cluster being interpreted as con-
stituting drawings from one normal distribution with a very
small variance and the rest of the sample as coming from
a second normal distribution with a very much larger variance.
This is known as the `singularity’ problem and can sometimes
produce results which are interpretationally nonsensical.
Thus, a restricted version of MLE is desirable in order to
assist in avoiding such interpretation problems. An ap-
proach which was found fruitful, and used in this paper, is
the so-called `quasi-Bayesian’ MLE approach suggested by
Hamilton (1991). Essentially, an adjusted version of the
likelihood function which incorporates a priori information
about the unknown means and variances is maximized
instead of the unrestricted function.1 In the rest of the paper,
2 4
m 2
the algorithm as just described will be referred to as HMRS
i
i for Hamilton Markov Regime Switching).
 864 A. P. L ayton
T he BryÐ Boschan turning point method of the tentative dates obtained from the previous step.
This results in a new set of tentative dates obtained from
Bry and Boschan’s (1971) purpose was to devise a computer
the short-span moving average. Finally, peaks and troughs
algorithm that was capable of closely approximating the
in the original series are identi® ed in neighbourhoods
subjective judgements of National Bureau of Economic
(6 MCD or 6 four months, whichever is longer) of the
Research (NBER) business cycle experts about a series’
tentative dates obtained from the short-span moving
turning points. The algorithm essentially seeks ® rst to ident-
average. If these dates satisfy the duration constraints
ify major cyclical swings. It then establishes neighbour-
they then become the ® nal peak and trough dates for the
hoods of the peaks and troughs, and systematically narrows
series.
the search in these neighbourhoods until the ® nal peak and
trough dates are determined. Three constraints are placed
on this searching process. First, no cycle (measured peak-to-
peak or trough-to-trough ) can be less than 15 months in
III. APPLICATION TO CIB CR C OINCIDE NT
duration. Second, no phase (expansion or contraction) can
INDEX
be less than ® ve months in duration. Third, no turning point
is recognized within six months of the beginning or end of
The HMRS algorithm was applied to monthly growth rates
the series.
in the CIBCR coincident index for Australia (denoted CO)
Major cyclical swings are identi® ed by applying a centred,
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using data spanning the period 1950(2) to 1994(11).2 Com-

unweighted, 12 month moving average to the data. Tenta-
ponents of this index are supplied in Table 1. The parameter
tive peaks (troughs) are identi® ed as the highest (lowest)
estimates of the HMRS model are provided in Table 3. Of
values in the neighbourhood of 11 months (6 ® ve months)
some interest are the absolute and relative magnitudes of
while adhering to the above three constraints.
the estimated transition probabilities. The relative values
A Spencer Curve (a centred, weighted moving average) is
re¯ ect the stylized fact that expansionary swings are much
then obtained from the data and peaks and troughs identi-
longer than contractions (the economy is relatively more
® ed as above. Again, taking the three constraints into ac-
likely to stay in an expansion than it is to stay in a contrac-
count, any peak (trough) in the Spencer Curve within the
tion). The expected length of an expansion (contraction) is
neighbourhood (6 ® ve months) of an identi® ed peak
given as 1/(1 - p)(1/(1 - q)) and computed as 33.3 (14.9)
(trough) in the 12 month moving average curve is taken as
months. These may be compared with the actual median
the new tentative peak (trough) date. This is done because
lengths for expansions and contractions given in Table 2. As
the Spencer Curve entails less smoothing than the un-
can be seen, the correspondence is close for contractions but
weighted 12 month moving average and therefore its turns
somewhat di€ erent for expansions. The latter di€ erence
are likely to be closer to those of the original data.
occurs mainly because of the three extra cycles detected by
Next, a short-span moving average, determined by the
HMRS (see below for a discussion of this).
series MCD,2 is obtained from the data and its peaks and
The estimated contractionary regime probabilities for
troughs identi® ed within neighbourhoods (6 ® ve months)
each data point of CO, presented in Fig. 1, were then used
to determine the timing of phase shifts in the index. A simple
rule was employed to determine dates. Given the series was
Table 3. Parameter estimates for coincident index currently in an expansionary phase, a contractionary phase
shift was identi® ed as having occurred if a run of at least ® ve
Parameter Estimate Standard error of these probabilities in a row exceeded 0.5. An expansion-
ary phase shift was identi® ed as having occurred if a run of
u1 - 0.3362 0.0707 at least ® ve of these probabilities in a row were less than 0.5,
u2 0.7204 0.0324 given the series had been in a contraction.
s 1 0.7246 0.0404 The motivation for this rule-of-thumb is simple. A prob-
s 2 0.5572 0.0209 ability exceeding 0.5 implies the corresponding growth rate
p 0.9331 0.0237 would more likely have come from the contractionary re-
q 0.9699 0.0107 gime than from the expansionary regime. The required run
of ® ve months is analogous to the minimum phase dura-
Note : Standard errors were obtained from an empirically- tion requirement incorporated into the BryÐ Boschan turn-
derived information matrix for the parameter estimates. ing point program and which explicitly acknowledges the

2
In traditional business cycle analysis an important part of the determination of turning points is the calculation of a series MCD
(standing for `months for cyclical dominance’). Essentially the MCD is the span of moving average required to produce a smoothed series
in which the cyclical component of the series dominates the irregular component. In the case of the series under study here all had an MCD
of 1. In practical terms this means that no prior smoothing of the indexes is required before taking growth rates.
 Dating and predicting Australian business cycle phase changes
Fig. 1. Regime probabilities (coincident index)
Note: Graphed points refer to the probability that the period
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comes from the contractionary regime.
traditional view that no contraction or expansion should be
recognized unless it is of su cient duration, namely ® ve
months. This phase change recognition rule is referred to as
COP(5). The actual date of the peak (trough) is usually
selected as the month preceding the ® rst negative (positive)
growth rate given the con® rmation of the contractionary
(expansionary) phase being in evidence.
As is evident from the table there is a close, though not
exact, correspondence in the phase shift dates in the coinci-
dent index given by BryÐ Boschan and those determined
using HMRS and the above dating system. The greatest
deviation occurred at the most recent trough. Furthermore,
HMRS misses one expansion (3/75 to 9/76) altogether and
signals three additional contractions (1/57 to 12/57, 8/71 to
1/72, and 6/86 to 11/86). All of these di€ erences warrant
further discussion.
The 6/92 trough date is not at all clear-cut. Four out of
the next six monthly growth rates were actually negative.
However, the fact the ® rst two were fairly large and positive
results in the level of the series at 6/92 remaining lower than
the level at 12/92, suggesting 6/92 as the appropriate turning
point. Nonetheless, it would have to be said that the Austra-
lian economy was not obviously in recovery mode until the
end of 1992.
The expansion of 3/75 to 8/76 which HMRS missed was
similarly an extremely anaemic one. For instance, in six out
of the 18 months of expansion, the index failed to register
positive growth, and in only two months did growth rates
exceed the estimated mean index growth rate for Australian
3
Growth cycles are cyclical ¯ uctuations in a series’ movements around its long term trend. A peak occurs when the series is furthest above
its trend level and a trough is reached when it is furthest below its trend.
865
expansions (see Table 3). The result was that the value of the
index at the peak of 9/76 was actually lower (by 2%) than
the earlier peak of 7/74. This was the only instance in the
postwar record where this occurred.
Moving to the three additional contractions (and, there-
fore, associated expansions) which HMRS detected, three
points should be made. First, all three periods (see above)
correspond to growth recessions in Australia.3 The o cial
CIBCR dates of these growth recessions are 8/55 to 1/58,
5/70 to 3/72, and 11/85 to 3/87. Thus, while the BB method
does not register them as contractions they, nonetheless,
were periods of very weak (and, in many months, negative)
growth.
Secondly, two of them were only of marginal duration,
lasting only the minimum period of ® ve months. A longer
minimum duration, say the two quarter (six months)
requirement o cially used in Australia, would exclude
these short contractions. Finally, the ® rst contraction,
while quite long, would imply a duration from peak to peak
(12/55 to 1/57) of 13 months. This violates the
NBER requirement that a cycle must be at least 15 months
long and, for this reason, was excluded by the BB method.
The contraction, however, nonetheless occurred and it
could be argued that it is su ciently important that it
should be regarded as part of Australia’s business cycle
record.
Thus, in the light of the above discussion, the perfor-
mance of CO(5) using HMRS may be regarded as accept-
able. Perusal of the regime probabilities in Fig. 1 also
reveals that, on no occasion were there any runs of three
probabilities greater (less) than 0.5 which did not
continue to be runs of ® ve. This suggests that a more useful
practical, timely recognition signal (denoted CO(3)) for
a contraction (expansion) would be the observation, in real
time, of a run of three regime probabilities greater (less) than
0.5, given the economy was currently in an expansion (con-
traction).
Use of CO(3) means that recognition of phase changes
in real time will usually occur about four months (allow-
ing for publication delay) after the event. This is a
desirable improvement over relying on GDP and the two
consecutive quarterly growth rate convention. This con-
vention means that, given publication delays, recognition
veri® cation does not occur for some nine to 10 months after
the event. However, what is really required for e€ ective
counter-cyclical macroeconomic policy adjustment is an
advance warning signalling system which could give policy-
makers a reliable signal of upcoming contraction (expan-
sion) at least four to six months ahead of time, even allowing
for publication delays. A possible such system is discussed
next.
 866
IV. APPLIC ATION TO CIBC R LEA DING
AND LONG-L EADING INDEXES FOR
AUSTRALIA
CIBCR maintains a leading index (LD) of economic indi-
cators for Australia which has been designed for the purpose
of providing advance warning of phase changes in the Aus-
tralian economy. In addition, CIBCR has recently de-
veloped a long-leading index (LL) of economic indicators
which has been designed to provide even longer leads than
the leading index in anticipating such phase changes. Com-
ponents of these indexes are supplied in Table 2. In this
section the results of applying the HMRS algorithm to LD
and LL are discussed in terms of their potential usefulness
as an advance signalling system.4
Consider LD ® rst. Perusal of the calculated contraction-
ary regime probabilities (not supplied here) revealed that, on
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A. P. L ayton
lities being greater (less) than 0.5 this was considered a true
signal. Otherwise the LD signal was regarded as having
been false. Finally, the number of months prior to a business
cycle turn at which the LD phase began served to de® ne the
lead at that business cycle turn. Results are reported in
Table 4 where, not only are the BB-de® ned phase dates for
the Australian business cycle used, but also the three extra
cycles in CO detected by HMRS in its application to that
index (discussed above).
Of particular interest is that none of these business cycle
turns is missed using LDP(3). Also, only one `false’ signal of
a peak is in evidence. Thus, over the historical record,
LDP(3) is 100% reliable as far as troughs are concerned and
just over 90% reliable as far as peaks are concerned. It
should also be pointed out that the `false’ contraction of
7/64 to 1/66 is nonetheless quite consistent with the CIBCR-
determined growth recession of 4/65 to 8/67. Therefore, the

only one occasion over the entire period, did a run of three
consecutive probabilities greater than 0.5 (indicating the
start of a contraction in LD) fail to turn into a run of at least
® ve (thereby satisfying the de® nition of a contractionary
phase change in LD).
Therefore, given the economy was currently in an expan-
sion (contraction), a signal of a business cycle contraction
(expansion) was considered to have been given by LD when-
ever a run of three probabilities greater (less) than 0.5 was
encountered (subsequently referred to as LDP (3)). This
signalling rule is analogous to the previous discussion of CO.
If the business cycle peak (trough) subsequently occurred
within the ensuing span of the run of LD regime probabi-
overall performance of LD may be considered to be very
encouraging evidence for its use as part of a signalling
system.
As to leads at these phase change dates, the median lead
at peaks is ® ve months and four months at troughs. Unfor-
tunately, these leads are really too short for LD alone to
serve as a very useful advance signal of upcoming phase
changes. For this reason the CIBCR long-leading index
(LL) was investigated in a similar way to LD with the signal
denoted as LLP(3). Results are also presented in Table 4.
It should be noted that a true LL signal of a phase change
in the business cycle is de® ned as a situation where a phase
change in LL spans at least the start of a similar phase in

Table 4. L eading indicator analyses using HMRS

Leading index leads1 Long-leading index leads1

Phase change dates using LDP (3) using LLP (3)

Peaks Troughs Peaks Troughs Peaks Troughs

4/51 8/52 +1 0 2 3
12/55 8/56 3 3 15 3
1/57 12/57* +4 1 +5 1
12/60 9/61 4 5 10 4
8/71 1/72* 17 1 21 11
7/74 3/75 11 5 17 6
9/76 11/77 0 1 3 11
9/81 5/83 6 9 3 9
6/86 11/86* 10 8 10 9
4/90 6/92 11 18 14 29

Median lead: Peaks = 5 months Median lead: Peaks = 10 months

Troughs = 4 months Troughs = 7.5 months
Extra cycles:7/64 (P) - 1/66 (T) Extra cycles:11/64 (P) - 1/66 (T)
Notes. * These denote contractions recognized by HMRS applied to CO but not recognized by
BryÐ Boschan.
1
A + indicates the index lags the phase change date.

4
In the interests of brevity the parameter estimates for LD and LL have not been provided. These are available upon request from the
author.
 Dating and predicting Australian business cycle phase changes
LD which, in turn, spans the date of the business cycle turn.
Thus, since LL is designed to have longer leads than LD it is
not required that the actual business cycle turn be spanned
by the corresponding phase in LL (as is the case of LD), but
it must, however, at least span the start of the corresponding
phase in LD.
On this basis, using LLP(3) as the signal, it should ® rst be
noted that, on each occasion an LLP(3) signal was given, the
actual span of the ensuing LL phase was at least ® ve
months. Furthermore, no business cycle turn was missed by
LLP(3). The median lead at peaks was 10 months and 7.5
months at troughs. These longer median leads imply that
incorporating LL is potentially of greater use than using LD
alone in a signalling system.
Also, on no occasion did LL enter a contractionary phase
without a corresponding contraction occurring in LD. Fi-
nally, by using LLP(3), it was again the case that only one
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`false’ contractionary signal was in evidence. No false signals
of recovery were given by LLP(3). In other words, as with
LD, LLP(3) was 100% reliable in anticipating recoveries
and over 90% reliable in anticipating contractions over the
historical record. It is again also important to note that this
false signal of classical recession nonetheless corresponded
to the growth cycle recession of 4/65 to 1/68. In other words,
it could be concluded that the LLP(3) contraction signal
was also 100% reliable in the sense it correctly signalled all
classical recessions and also anticipated the only remaining
additional growth recession in the historical record not
accounted for by the classical recessionary periods.
Clearly, LLP(3) has a great advantage over COP(3), and
also to a lesser extent over LDP(3), in providing timely
information about peaks in the business cycle; i.e. in antici-
pating recessions or growth slowdowns. Using LLP(3) the
median warning of upcoming recessions over the historical
period would have been approximatel y ® ve to six months in
real time (obtained by subtracting from 10 months an allow-
ance of one month for publication delay and three to four
months for the signal to be received).
If, as may often be the case, the RBA is running a tight
monetary policy in the run-up to a peak, ® ve to six
months advance warning of the arrival of a contraction
can allow the policy to be eased o€ early; perhaps even
early enough to achieve the fabled `soft landing’. Also of
great practical importance from a monetary policy perspect-
ive is that one of the components of LL is the 10 year
government bond yield rate. Thus, the e€ ect of current
monetary policy, in a very explicit sense, is incorporated
into the computed likelihood of a future contractionary
phase change.
V. C O N C L U S I O N S
It has been shown that a simple dating rule using HMRS-
generated regime probabilities for the CIBCR coincident
867
index for Australia provides a close replication of the phase
change chronology, as is provided by the BryÐ Boschan
algorithm for that index. The advantages of HMRS are its
simplicity and objectivity and, perhaps more importantly,
its potential to recognize phase changes more quickly than
BryÐ Boschan in real time.
It was also found that a simple, advance warning system
based upon the HMRS-generated regime probabilities from
the long-leading index (LLP(3)) proved very reliable in sig-
nalling all business cycle peaks (with a median lead of 10
months) and troughs (with a median lead of 7.5 months). No
turns were missed and only one extra peak was signalled.
However, even this additional signalled contraction corre-
sponded to a growth recession in Australia.Thus, in a sense,
LLP(3) performed with 100% accuracy. In real time, after
allowing for a one month publication delay and three to
four months for the signal to be received, the median leads
in practice would be expected to be ® ve to six months at
peaks and two to three months at troughs.
It was also found that no business cycle phase change
occurred without the commencement of correspond-
ing phase changes in both the long-leading and leading
indexes. Thus, in practical terms, this suggests that a busi-
ness cycle peak only becomes imminent once both the
LLP(3) and LDP(3) signals are received. However, at
troughs, LLP(3) is likely to be much more useful due to the
shorter median lead of LD. These results suggest the use of
HMRS, as described here, could prove very fruitful in the
early anticipation, and timely recognition, of business cycle
phase changes.
At least two potentially useful areas of further research in
this line are as follows.
The transition probability parameters are assumed ® xed
in this application. This may or may not be a realistic
assumption. It implies the probability of a phase change
(cet. par.) is independent of the length of time the series has
been in the current phase. Views are mixed as to whether
this is realistic in the context of business cycles. This issue
could be further investigated.
The current application of HMRS is essentially uni-
variate in nature. Another potentially interesting line
of investigation would be to make it explicitly bivariate
by making the state variable (St) a vector (rather than
a scalar) describing the state, not only of the coincident
index, but also that of the long-leading index. The purpose
would be to try to model objectively the practical presump-
tion that once LL has turned it is relatively more likely that
CO will turn.
REFERENCES
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Selected Procedures and Computer Programs. Technical Paper
20, NBER, Columbia University Press.
 868
Burns, A. F. and Mitchell, W. C. (1946) Measuring Business Cycles.
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Hamilton, J. (1990) Long swings in the dollar. Are they in the data
and do markets know it? American Economic Review, 80,
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