Abstract:
We test for a unit root in de-trended GDP in a two-state Markov switching specification
using a modified Augmented Dickey-Fuller test. Our results show that a first difference GDP
specification is preferred over the de-trended specification. In addition, the null of differencestationary
GDP cannot be rejected. By implication, shocks to GDP are permanent which
validates specifying trend GDP with a stochastic component – something that is inherently
assumed in a number of research papers that estimate potential GDP growth and that model
GDP in general equilibrium specifications.