Friedman's Plucking Model of Business Fluctuations: Tests and Estimates of Permanent and Transitory Components

More than thirty years ago Milton Friedman proposed a `plucking' model of business °uctuations in which output cannot exceed a ceiling level, but will, from time to time, be plucked downward by recession. The model implied that business °uctuations are asymmetric, that recessions have only a temporary e®ect on output, and that recessions are duration dependent while expansions are not. Subsequent literature has provided copious empirical support for these propositions, but econometric models of business °uctuations have not incorporated these features. This paper presents a formal econometric model which encompasses both plucking and asymmetric °uctuations around a stochastic trend while allowing for heteroscedasticity and shocks to the growth rate. We ̄nd that U.S. real GDP is well characterized by Friedman's plucking model, that implied recessions correspond closely with NBER reference cycles, and no substantial role for symmetric cycles. Decomposition of the unemployment rate reveals a corresponding asymmetry and timing but with di®erent dynamics. Time paths of the implied ceiling level of output and the trend rate of unemployment are presented.