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Sources of the Great Moderation: shocks, friction, or monetary policy?

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  • Zheng Liu
  • Daniel F. Waggoner
  • Tao Zha

Abstract

We study the sources of the Great Moderation by estimating a variety of medium-scale DSGE models that incorporate regime switches in shock variances and in the inflation target. The best-fit model, the one with two regimes in shock variances, gives quantitatively different dynamics in comparison with the benchmark constant-parameter model. Our estimates show that three kinds of shocks accounted for most of the Great Moderation and business-cycle fluctuations: capital depreciation shocks, neutral technology shocks, and wage markup shocks. In contrast to the existing literature, we find that changes in the inflation target or shocks in the investment-specific technology played little role in macroeconomic volatility. Moreover, our estimates indicate much less nominal rigidities than those suggested in the literature.

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Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2009-01.

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Date of creation: 2009
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Handle: RePEc:fip:fedfwp:2009-01

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Keywords: Econometric models ; Business cycles;

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