Question

Explain two reasons why you should take the natural log of macroeconomic time series before you apply the HP filter to them.

Answer 1

We take natural log of time series data before applying HP filter to it because:

1) It makes data much more reliable to fit into our model be it linear or non- linear.

2) when there is exponential growth in the data of our model, then by taking natural log it can transform the data and making it more straighter.

3) We can remove heteroscedasticity from our model.

Heteroscadasticity is a situation when error term is not same across all values of independent variable.