National Institute Economic Review

Recent estimates suggest that the UK business cycle is closer to the Euro zone business cycle than it was in the early 1990s. This paper investigates whether this phenomenon has been accompanied by increased correlation between UK and Eurozone business cycles. Considering a range of alternative measures of the business cycle we find, using 40 years of monthly industrial production data, no clear evidence for a sustained increase in correlation between UK and Eurozone business cycles. Instead, in the 1990s, the correlation between UK and Eurozone business cycles has been volatile relative to historical levels. It is only recently, i.e. since 1997, that the UK has become more correlated with the Eurozone, although the level of correlation is lower than against non-Eurozone countries. Importantly, the strength of these relationships is sensitive to how the business cycle is measured. Care should therefore be exercised when using business cycles estimates to test the relationship between UK and Eurozone business cycles.

We outline a number of ‘stylised’ facts on the UK business cycle obtained from analysis of the long-run UK annual dataset. The findings are to some extent standard. Consumption and investment are pro-cyclical, with productivity playing a dominant role in explaining business cycle fluctuations at all horizons. Money neutrality obtains over the long run but there is clear evidence of non-neutrality over the short run, particularly at the business cycle frequencies. Business cycle relationships with the external sector via the real exchange rate and current account are notable. Postwar, the price level is counter-cyclical and real wages are pro-cyclical, as are nominal interest rates. Modern general equilibrium macroeconomic models capture many of these patterns.

The NIESR’s monthly GDP series is an innovative feature; most GDP estimates are published at an annual, or quarterly frequency at best. For purposes of dating the business cycle the availability of this series is an asset, unexploited until this paper. The paper applies a version of the standard business (or ‘classical’) cycle dating algorithm to the data, after light smoothing to remove outliers. Three classical cycles are detected in the period between the early 1970s and 2002, with turning points which are close to (but usually precede) classical cycle dating which does not benefit from the availability of monthly GDP, and instead relies on a ‘coincident’ indicator methodology. In addition the turning points of a deviation cycle are identified.

This paper discusses recent research at the Centre for Growth and Business Cycle Research on the prediction of the expansion and recession phases of the business cycle for the UK, US, Germany, France and Italy. Financial variables are important predictors in these models, with the stock market playing a key role in the US but not the European countries, including the UK. In contrast, international linkages are important for the European countries. Our models suggest that the US and German economies have now emerged from the recession of 2001, and that all five countries will be in expansion during the third quarter of this year.