Predicting UK Business Cycle Regimes

Following on from the work of Birchenhall, Jessen, Osborn & Simpson (JBES, 1999) on predicting US business cycle regimes we apply the same methodology to construct a one period ahead model of classical business cycle regimes in the UK. Birchenhall et al (1999) used regime data implied by the NBER dating of peaks and troughs. In the UK there is no comparable dating committee and our first task is to date the UK peaks and troughs. Application of a simple mechanical rule based on changes in GDP produces a set of acceptable turning points, with one exception that is attributable to the 3-day working week in 1974. Based on data from 1963 to 1999, we date three business cycle peaks at 1973 Q3, 1979 Q2 and 1990 Q2 together with troughs at 1975 Q3, 1981 Q1 and 1992 Q2. Starting with a number of real and financial leading indicators, several parsimonious one-quarter-ahead models are selected largely on the basis of the SIC criterion. A number of interesting results emerge from this investigation. A real M4 variable is consistently found to have predictive content. One model that performs well combines this with UK and German short-term interest rates. The role of the latter variable emphasises the open nature of the UK economy.