Characterising the South Africa business cycle : is GDP difference-stationary or trend-stationary in a Markov-switching setup?

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.