1 Modelling Business Cycle Movements in the UK Economy Paul W. Simpson* Denise R. Osborn† Marianne Sensier† *Department for Education and Employment, Sheffield †Centre for Growth and Business Cycle Research School of Economic Studies University of Manchester, Manchester, M13 9PL, UK e-mail: Marianne.Sensier@man.ac.uk web address: http://www.ses.man.ac.uk/cgbcr/ 29 th March 2000 Abstract 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 to 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 the nominal interest rates are used to generate the regime-switching probabilities. JEL classification: C22, C32, E32, E37, E44. Keywords: Financial variables, business cycle, leading indicators, TVTP Markov-switching regime models.