9.

NOMINAL AND REAL STYLIZED FACTS OF THE BUSINESS CYCLES IN THE ROMANIAN ECONOMY
Petre CARAIANI*

Abstract
This paper analyses the nominal and real characteristics of the Romanian business cycles over the period 1994-2003. As a proxy for the aggregate fluctuations, we use the index of the industrial production. The results confirm the great role of nominal and real rigidities in the mechanism of the business cycles in the Romanian economy.

1. Introduction
The field of the business cycles is one of the most dynamic and controversial in the economics. That is because the explanation of the shocks that produce them and of the propagation mechanisms through which they work it is the true test for any macroeconomics school of thought. In the recent years, in the economics fluctuations theory the debate is dominated by the New Keynesian school (NK henceforth) and the Real Business Cycle school (RBC henceforth). On the one hand, we have a central role for the nominal rigidities that make the business cycles possible due to the sluggish adjustments. Thus, according to the NK the monetary disturbances that affect only the demand can cause fluctuations in the economic activity. The RBC theory supports the view that the fluctuations can be explained in a Walrasian framework - a competitive model where markets are clearing, there is lack of imperfections, externalities or asymmetries. According to the RBC, the shocks that trigger the business cycles are the technological shocks, while the aggregate fluctuations are the results of the aggregated optimal decisions of the representative household. Most of the business cycles studies were made for the G7 countries, many of the stylized facts being common for most of these countries. In the last two decades, the topic of business cycles has started to be studied in the case of the emerging economies, too. For the emerging economies, the usual assumption is that of a small open economy. Potentially, the assumption of small open economy coupled with that of a developing economy leads to some characteristics that play a role in the fluctuations:
*

Institute of Economic Forecasting, Bucharest, Romania.

the economy is more unstable, there is vulnerability to the exchange rate shocks, the financial sector of the economy is underdeveloped. In this paper we will look for the specific of the business cycles in Romania, trying to explain them in the context of transition and the changing structures of the economy.

2. The Methodology
We will follow the Kydland and Prescott (1990) approach, studying the behavior of real (output, employment, wages) and nominal variables (monetary variables, prices, exchange rates) for the Romanian economy. In our study of the business cycles, we will consider the modern definition of the business cycles, as Lucas (1977) had defined them where the aggregate cycles are the deviations of the real output from its trend. The term trend comes from the fact that in the industrialized countries the output has a long-run tendency to increase slowly. The traditional identification of trend has been the HodrickPrescott technique (henceforth HP), the recent years giving us a larger set of possibilities. The HP technique emerged in the context of the formation of RBC school. The HP consists in a filter that extracts the long-run component of a given series. The series is assumed to be de-seasoned and is expressed in logarithms. The necessity of expressing the series in natural logarithms comes from two advantages given by this method: we are interested in the percentage deviations of the series from its smooth trend and we also obtain by applying logarithms series that are linear over time, assuming that the initial series are exponentially growing in time. The mathematical representation of this filter is:

(y
i =1

g t ) 2 + [( g t +1 g t ) ( g t g t 1 )]2
t =2

T 1

where penalizes the variation in the growth component. A lot of debate has aroused regarding the optimal values of the , which has an essential role in obtaining the cycle component. Hodrick and Prescott have argued that starting from the fact that a 5% variation in the cycle component is large enough as it is one-eighth of a percent change in the quarterly growth component; one can deduct the value of lambda as:

cycle trend

obtaining =1600 for quarterly data. Some studies have questioned the applicability to other countries as this value was obtained for the US data. For the monthly time series we use the default value =14400, as given in Eviews. After we identify the cycle component for the reference series (industrial production) and for the main macroeconomic variables, we test their stationarity by using unit root tests. The results show us that all the cyclical components obtained are stationary. The final stage consists in studying the economic fluctuation by their volatility, degree of comovement of the cyclical component of the macroeconomic variables (real or

nominal) with the cyclical component of the aggregate fluctuation, proxied by the cycle of the industrial production, and of the phase shifting with respect to the economic cycles. We use the contemporaneous correlation coefficient to detect the comovement of the cyclical variable. For a negative contemporaneous correlation coefficient, we say that the series is countercyclical, for a positive one, procyclical, while a correlation coefficient closed to zero tells us that the series is acyclical. We will use the correlation coefficient at log j where j(1,2,,12) to detect the cyclical behavior of the series in regard with their phase shifting. For a procyclical series, we say that the series is leading or lagging if the lag with the highest positive correlation coefficient is negative or positive, respectively. For a countercyclical series, we say that the series is leading or lagging if the lag with the highest negative correlation coefficient is negative or positive, respectively.

3. Dating the business cycles in Romania

In the developed countries, as a measure of the aggregate fluctuations usually one uses the quarterly real GDP. Since this economic indicator it is not available for Romania before 1997, we will make use of the monthly index of industrial production as a measure of the aggregate activity. This is the indicator used in most of the studies of business cycles in the emergent economies, for similar reasons. One possible criticism to this choice is the fact that the share of the industry has fallen in the total GDP, but it can be argued that we use the cycle component of the series, the trend being eliminated. Another possible negative aspect is the fact that the fluctuations in the industrial production are much more pronounced that those in the aggregated activity, but this is more difficult to demonstrate. By extracting the cycle component of the index of the industrial production, we can date the business cycles in the Romanian economy, by establishing the turning points, the peaks and the troughs in the economic activity. Table 1

Dating the Business Cycles in Romania

Peaks August 91 December 96 March 01 64 months 51 months Duration from Peak to Peak August 92 July 99 83 months Troughs Duration from Trough to Trough

The dating of the business cycles shows a decrease in the duration of the business cycles towards four-five years (a fact that can be verified when comparing to the cycles of the annual GDP), a duration which is specific to the developed countries.

Figure 1

Business Cycles in the Romanian Economy

.1 5 .1 0 .0 5 .0 0 -.0 5 -.1 0 -.1 5 1992 1994 1996 1998 CYCLE 2000 2002

Since the period is small for analyzing the business cycles, we cannot but assume that the period of large swings is over, and except some huge shocks, the aggregate fluctuations in Romania will tend to look similar to those in the developed countries as regards persistence, volatility and asymmetry between expansions and recessions. The volatility of the business cycles is higher than in the developed countries, a fact caused by the large shifts in the structure of the economy and the restructuring process that took place. It is expected that the volatility will tend towards levels common to the developing economies, given the absence of large shocks (see McDermott (1999)).

4. Nominal and Real Characteristics of the

Romanian Business Cycles
4.1. The Prices
As a measure of prices, two different variables are used: the level of prices (and one can use either the CPI or the GDP deflator) or the inflation rate. The difference may seem unimportant but as the studies of the cyclical behavior of the prices in the developed countries show, contrasting results for the two variables are quite often obtained. We will study both the cyclical properties of the level of prices and of the inflation rate. Figure 2

CPI and Industrial Production Cycles

.2

.1

.0

-. 1

-. 2

-. 3 94 95 96 97 98 99 00 01 02 03

C Y C L E _ IP

C YC LE_C P I

The results show us that while the prices are countercyclical (R(0)=-0.35) and leading by ten months, the inflation rate is acyclical, while having a much larger volatility. We will consider only the results for the level of prices, as showing us the behavior of prices. In Keynes General Theory, prices are flexible and taken as procyclical, this hypothesis playing a central role in this theory of short run fluctuations. As the statistical tests have shown, the prices were indeed procyclical in the pre WW2 period. Nevertheless, the economists have continued to assume the procyclicity of the prices in the post war period, without testing it, and here the famous Koopman critique (1947) on the reporting of business cycles facts without any theory to back up them has played an essential role. More recently, this prevailing view has been contradicted by the RBC school. Kydland and Prescott (1990) have shown that in the post Korean war period, in the United States the prices have been clearly countercyclical. Their finding was confirmed by other studies Cooley and Ohanian (1991), Backus and Kehoe (1992) and Smith (1992). While there appears an agreement on the fact that the level of prices is countercyclical, some other studies have showed that the inflation rate is procyclical for the most developed countries. Some studies were undertaken for the developing countries, too. McDermott (1999) finds for some countries countercyclical price behavior, while for other he finds a procyclical pattern. The countercyclical pattern of the prices is usually interpreted as a reason against the demanddriven models.

4.2. The Wages

We will use two measures of the wages the nominal average wage per month and the real average wage per month (the nominal wage deflated by the CPI). Figure 3

Real Wages and Industrial Production Cycles

.2

.1

.0

-. 1

-. 2

-. 3 9 4 9 5 9 6 9 7 9 8 9 9 0 0 0 1 0 2 0 3

C Y C L E _ IP

C YC L E _ W R

The results for the cyclical properties of the wages, both real and nominal show a much clearer picture. Both of them are leading (the nominal wage by four months while the real wage is leading the economic fluctuations by five months) and countercyclical (the nominal wage has a stronger countercyclical character). These results dismiss a possible real business cycle approach to the understanding and modeling of the business cycles in Romania. In the RBC framework, the real wage is procyclical, and theoretical it should show a strong procyclicity (close to one). The evidence from the developed countries (especially US) shows a moderate to weak procyclical character. The Keynesian explanation of the business cycles makes the central point from the nominal rigidities. In the initial form of the General Theory (1936), Keynes expressed the view that the nominal wages are rigid in the short run and the prices are flexible. Thus, in the case of a recession, the prices are going down and given the short run rigidity of the nominal wage, the real wage becomes countercyclical. The hypothesis of the countercyclical real wage has been contradicted by the statistical tests on the real data that were undertaken a short while after the publication of the Keyness contribution. It has also been proven that in the post war period, in the developed countries the real wages have been proven proczclical. McDermott (1999) in the study on the emerging economies business cycles also finds a prociclicity of the real wages in most of the countries included in the sample. As a response to the early studies on the cyclical behavior of the real wage, Keynes (1939) has formulated a new view in which the nominal wage is rigid, the nominal

prices are flexible but there are some imperfections also in the goods market. The hypothesis that the goods market has some rigidity is expressed by the fact that the price is a markup over the price. Given the well known fact the markups are countercyclical (Rotember and Woodford (1999)), which means that they are lower in expansions than in the recessions, the real wage may become procyclical. The countercyclical behavior of the nominal and real wage confirms the rigidities of the Romanian economys labor market.

4.3. The Role of the Money

One of the fundamental questions regarding the nature of business cycles is about the role of the money, or to use the well-known expression whether the money are neutral. Up to the apparition of the RBC school there was a consensus on the fact that money do matter. The debate was between what was a good monetary policy and what was a bad monetary policy and, in the mainstream thinking, the place of the money in the business cycles theory was well established. In the RBC theory, where the impulses that trigger the business cycle are the technological shocks and the propagation mechanism is by the intertemporal allocation of leisure and hours of working, changes in the monetary variables do not change the real variables but just the nominal ones. Therefore, the monetary shocks do not have any influence on the real economy. The New Keynesian school admits a role to the monetary side of the economy, because the monetary shocks do influence the real activity due to the rigidities in the short run of the prices and wages. Figure 4

Real Money Supply and Industrial Production Cycles

.2 0 .1 5 .1 0 .0 5 .0 0 -. 0 5 -. 1 0 -. 1 5 94 95 96 97 98 99 00 01 02 03

C Y C L E _ IP

C YC LE _M 2R

We obtain contrasting results for the cyclical behavior of the money supply, depending on the fact whether it is real or nominal. For the nominal money supply we get a very weak countercyclical behavior, close to an acyclical one, with a leading tendency of five months. Meanwhile, the real money supply has a moderate procyclical behavior and is leading the aggregate fluctuations by ten months. Given the large fluctuations in the level of prices and the clearer pattern for the real balance of money, we consider that the real M2 gives us the measure of the behavior of the monetary side of the economy. Theoretically, a leading and procyclical character of the money would sustain a NK approach but the RBC proponents have their explanation for the procyclical character of the money (in the US the monetary aggregates are procyclical but they lag the business cycles). They argue that M2 responds endogenously to the output fluctuations, because the rise in productivity during the booms leads to a rise in the demand for transaction services, the result being that the banking sector responds by increasing the money supply. This sale of the money can be underlined by the cyclical properties of the real nongovernment debt, which is moderately procyclical and is leading the business cycle by 12 months. The obvious role of the credit in the business cycles is a characteristic of a developing country, due to the lack of development of the financial markets. This stylized fact is confirmed for some other emergent economies by McDermott (1999). The leading and procyclical character of the real monetary variables suggests a possible money output causality relationship for Romania, which should be further investigated. Figure 5

Real Non-Government debt and Industrial Production Cycles

.4 .3 .2 .1 .0 -. 1 -. 2 -. 3 -. 4 9 4 95 9 6 97 98 99 00 01 02 03

C Y C L E _ IP

C Y C LE _ D B T

4.4. Other variables 4.4.1. The employment

In order to measure the fluctuations in the labor market we used two variables the numbers of employed and of unemployed persons, both in thousands persons. The two variables perform quite asymmetrical during the cycle. If the employment is almost acyclical the unemployment, measured by the number of unemployed persons, yields an obvious countercyclical behavior, with the contemporaneous correlation coefficient of -0.54, while it lags the cycle with five months. The explanation for this behavior rests in the fact that during the 90s a continuous process of restructuring in the labor market took place and many workers had to leave jobs in the inefficient companies. That is why the employment continued to fall even during the expansion periods, given the need for restructuring. As many of the people who lost their jobs received retirement packages, the number of unemployed did not take a pattern in line with the employment variable. Thus, the numbers of employed shows a weak to acyclical behavior, which cannot but give a partial confirmation of the rigidity of the labor market in Romania, contradicted by the countercyclical pattern of the unemployment. Figure 6

Unemployment and Industrial Production Cycles

.2

.1

.0

-. 1

-. 2

-. 3 94 95 96 97 98 99 00 01 02 03

C Y C L E _ IP

C YC LE_U N EM

4.4.2. The exchange rate

The recent Asian crisis shows that the exchange rates can play an important role as shocks that may cause business cycles, through the various channels by which they operate. As a variable we have chosen the real exchange rate, which is the nominal exchange rate deflated by the consumer price index.

For the Romanian economy, we find a moderate procyclical behavior (R(0)=0.38) and a leading character by eight months. These results confirm that in the case of Romania, as in that of many other small open economies, the exchange rate shocks influence the real output. The leading behavior of the exchange rate, as it is the case of the monetary variables such as real M2 and the real non-government debt, indicate a strong role played by the financial variables on the real side of the economy. Figure 7

Exchange Rates and Industrial Production Cycles

.1 5 .1 0 .0 5 .0 0 -. 0 5 -. 1 0 -. 1 5 -. 2 0 9 4 9 5 9 6 9 7 9 8 9 9 0 0 0 1 0 2 0 3

C Y C L E _ IP

C Y C L E _ E X R

5. Conclusions
We find a mix of patterns in the cyclical behavior of the macroeconomic time series. On the one hand, the RBC model seems to be strongly contradicted by the role of money in the output and the countercyclical pattern of wages, confirming rigidities in the labor market. On another hand, we depict a countercyclical pattern of the prices, which contradicts the basic demand-driven models. This mixture can be explained by the peculiarities of an economy in transition in process of full restructuring. Table 2

Cross correlations between cyclical activity and main macroeconomic variables

Variables Lag j CPI Inflation Rate -12 -0.53 -0.49 -10 -0.55 -0.43 -8 -0.54 -0.35 R((X(t),Y(t+j))* -4 0 4 -0.51 -0.35 -0.02 -0.16 0.04 0.30 8 0.24 0.47 10 0.32 0.50 12 0.35 0.46

Variables Nominal M2 Real M2 Real Non-government Debt Nominal wages Real wages Real Exchange Rate Employment Unemployment

-0.27 0.55 0.43 -0.48 -0.03 0.39 -0.34 0.25

-0.29 0.57 0.41 -0.55 -0.09

-0.32 0.54 0.37 -0.59 -0.12

R((X(t),Y(t+j))* -0.36 -0.17 0.06 0.46 0.34 0.05 0.34 -0.64 -0.14 0.23 -0.50 -0.24 0.00 -0.17 -0.39 0.37 0.35 -0.66

0.27 -0.18 -0.26 0.17 -0.36 0.21 0.44 -0.58

0.31 -0.25 -0.35 0.31 -0.23 0.06 0.49 -0.49

0.32 -0.27 -0.34 0.37 -0.06 -0.12 0.54 -0.41

Nominal Exchange Rate 0.46 0.48 0.41 0.38 -0.30 0.16 -0.24 0.04 -0.06 -0.30 0.15 -0.54

* Where X(t) is the cyclical component of the industrial production and Y(t+j) is the cycle of the variable selected.

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