Modelling Business Cycle Movements in the UK Economy

This paper models the phases of the UK business cycle using GDP data with a time‐varying transition probabilities (TVTP) Markov‐switching regime model and exogenous leading indicator variables. Single indicators in linear models are compared with the TVTP framework, with logistic and exponential functions used in the latter. The Markov‐switching models capture the major recessions of the sample, but the use of leading indicators through the TVTP framework can improve this regime recognition. Finally, a forecast comparison shows that the TVTP models perform relatively well in predicting during the 1990s, particularly when nominal interest rates are used to generate the regime‐switching probabilities.