A new approach to dating and predicting Australian business cycle phase changes

Due to well-known lags, counter-cyclical macroeconomic policies often exacerbate, rather than ameliorate, business cycles. Early recognition of upcoming phase shifts, particularly contractions, may assist in fine-tuning such policies. This objective is pursued in the paper by applying Hamilton's (1989, 1990, 1991) quasi-Bayesian, Markovian, regime-switching model to monthly growth rates of leading, long-leading and coincident indexes of Australian economic activity. A simple rule applied to regime probabilities for each data point of the coincident index produces a phase chronology that is very similar to that produced by the Bry and Boschan (1971) turning point algorithm. The regime switching model is also applied to the leading and long-leading indexes. The application of a simple rule to the resultant regime probabilities is found to result in a potentially very reliable advance signalling system for Australian business cycle phase changes.