Real business cycle - leading, coincident and lagging indices

Abstract

The earlier version of business-cycle models started from the story of Prophet Yusuf in Chapter Yusuf, verses 42-48.3 The Pharaoh of Egypt summoned Prophet Yusuf, then an imprisoned slave, to interpret two dreams. In the first, seven plump cattle were followed and devoured by seven lean, starving cattle. In the second, seven thin ears ate full ears of corn. After hearing these dreams, Prophet Yusuf prophesied that Egypt would enjoy seven years of prosperity, followed by seven years of famine. He recommended a consumption-smoothing strategy to provide for the years of famine, under which Pharaoh would appropriate and score a fifth of the grain produced during the years of plenty. According to the tafseer ibnu Khathir, Pharaoh embraced this plan, made Prophet Yusuf his finance minister, and thereby enabled Prophet Yusuf to save Egypt from starvation. The above verses have led towards a better understanding of macroeconomic fields. And it motivate us to draw the main objective of macroeconomic analysis, i.e., to provide a coherent explanation of aggregate movements of output, employment and price level, both in the short- and long-run. Then, the neoclassical macroeconomic theory dictates that aggregate demand and monetary shocks were the main sources of aggregate disequilibrium. The neoclassical school of thoughts assumes "full employment" represented equilibrium and recessions are considered disequilibrium periods of market failure. Thus, state intervention in the form of a stabilization policy is justified to return the economy to equilibrium. In their seminal paper, Kydland and Prescott (1982) offered an additional explanation of business cycles - they postulated that each stage of a business cycle (peak, recession, trough and recovery) is equilibrium in itself. Thus, the RBC school of thoughts rejects the market failure view of an economy in disequilibrium. Recessions represent the aggregate outcome of responses by economic agents to unavoidable shifts in the constraints that they face. As agents responded rationally to changes in their constraints, market outcomes which are displaying aggregate fluctuations are actually efficient. Thus, the research by Kydland and Prescott (1982) posed a serious challenge to all previous mainstream accounts of business cycles that focused on aggregate demand or monetary shocks. Hence, this paper is aimed to: identify business cycles for the Malaysian economy using the Malaysian System of Economic Indicators (SEI); and assess the effectiveness of the SEI in estimating the turning points of a cycle, especially a recession. The remaining discussion of this paper is as follows. Section 2 will briefly review the RBC theory. Section 3 will discuss the methodology adopted by this paper followed by a discussion on the results obtained in Section 4. Finally, Section 5 will discuss some strengths and weaknesses of the methodology adopted as well as some suggestions for improvements before Section 6 concludes.