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The roles of comovement and inventory investment in the reduction of output volatility

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Author Info
Owen Irvine
Scott Schuh
Abstract

More than 80 percent of the decline in the variance of aggregate output since 1984 is accounted for by a decline in the covariance (and correlation) of output among industries that hold inventories. Using a HAVAR macro model (Fratantoni and Schuh 2003) with only two sectors, manufacturing and trade, we show that this decline in comovement – and thus much of the Great Moderation in aggregate and industry-level output – is explained largely by changes in the structural relationships between sectors’ sales and inventory investment, rather than by “good luck.” A small part of the Moderation is explained by structural changes among interest rate parameters, but the case for better monetary policy is complicated by structural changes in the real side of the economy. We also show that the decline in comovement is concentrated in the automobile industry and related industries that are linked by supply and distribution chains. Immediately prior to the Great Moderation, these industries adopted new production and inventory management techniques, which may explain the structural changes.

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Article provided by Federal Reserve Bank of San Francisco in its journal Proceedings.

Volume (Year): (2007)
Issue (Month): Nov ()
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Handle: RePEc:fip:fedfpr:y:2007:i:nov:x:19

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