The Importance of Permanent and Transitory Components: Identification and Some Theoretical Bounds

Much macToeconometric discussion has recently emphasized the economic significance of the size of the permanent component in GNP. Consequently, a iarge iiterature has developed that tries to estimate this magnitude— measured, essentially, as the spectral density of increments in GNP at frequency zero. This paper shows that unless the permanent component is a random wedk this attention has been misplaced: in general, that quantity does not identify the magnitude of the permanent component. Further, by developing bounds on reasonable measures of this magnitude, the paper shows that a random waJk specification is biased towards estabhshing the permanent component as important.