Introduction

Conflicting views on the causes and nature of business-cycle fluctuationsusually can be attributed to different beliefs about the adjustments ofprices and wages. For example, Kydland and Prescott (1990) - KP hereafter- concluded that U.S. prices had been countercyclical since 1954and interpreted that as evidence against demand-driven models of thecycle. Those findings were based on the innovative “stylized-facts”method of KP, as further developed (Kydland and Prescott, 1991) andcontrasted with the econometric “system-of-equations” approach ofKoopmans (1947,1949).

The main reason for KP's dismissal of econometric models seems tohave been that results derived from system-of-equations models weremodel-dependent and represented biased evidence on the nature ofbusiness-cycle fluctuations (e.g., the “myth” that prices behave procyclically).As an alternative, KP offered their own stylized-facts method,which involved only a minimum of assumptions, thus allowing the datato speak directly, instead of through the veil of an econometric model.KP applied a filtering technique known in the economics literature asthe Hodrick-Prescott (HP) filter to the raw data in order to identify andremove the trend in the individual series.