The HP-filter in cross-country comparisons

Abstract

Many empirical studies of business cycles have followed the practise of applying the Hodrick-Prescott filter for cross-country comparisons. The standard procedure is to set the weight \lambda, which determines the 'smoothness' of the trend equal to 1600. We show that if this value is used for against common wisdom about business cycles. As an example, we show that the long recession occurred inSpain between 1975 and 1985 goes unnotoced by the HP filter. We propose a method for adjusting \lambda by reinterpreting the HP-filter as the solution to a constrained minimization problem. We argue that the common practice of fixing \lambda across countries amounts to chankging the constraints on trend variability across countries. Our proposed method is easy to apply, retains all the virtues of the standard HP-filter and when applied to Spanish data the results are in the line with economic historian's view. Applying the method to a number of OECD countries we find that, with the exception of Spain, Italy and Japan, the standard choice of \lambda=1600 is sensible.