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Contrary to the implications of some recent scholarly papers and blog entries, I conclude that a unit root in U.S. real GDP cannot be rejected in favor of trend stationarity. In addition to small-sample size distortion, sometimes addressed in the past, I adjust for the multiple test problem, which has never been addressed. I go on to estimate the economic importance of the unit root. It is important by three measures: (1) permanent shocks, inherent in a unit root, are of significant size relative to transitory shocks; (2) permanent shocks generate significant real GDP responses; and (3) models specifying permanent shocks give better forecasts than models without permanent shocks, most notably after seven post-World War II recessions. In particular, one should allow for both permanent and transitory shocks, and a bivariate vector error correction model with a specific identification of transitory and permanent shocks is clearly best of several unit root models examined.
Podcast related to this article: David Cushman on Transitory and Permanent Shocks to GDP (EJW Audio, January 2016).