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Macroeconomic volatility, predictability and uncertainty in the Great Moderation: evidence from the survey of professional forecasters

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  • Sean D. Campbell
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    Abstract

    An emerging and influential literature finds a large and significant decline in macroeconomic volatility since the middle of the 1980's. In this paper, I examine the extent to which the decline in annual and quarterly real output volatility since the onset of this period of Great Moderation can be attributed to changes in macroeconomic uncertainty and macroeconomic predictability. I use point forecasts of future real output growth from the Survey of Professional Forecasters (SPF) between 1969 and 2003 as a proxy for the predictable component of real output growth. The results indicate that declining predictability has played a significant role in the Great Moderation. Prior to the Great Moderation, professional forecasts explained roughly 30 percent of the variance in output growth. Post-moderation, the predictive ability of professional forecasts quickly vanished. This decline in predictability implies that interpreting the decline in the volatility of output shocks identified from a fixed parameter autoregressive model overstates the decline in macroeconomic uncertainty by between 20-40 percent. I also examine forecasts of the probability of a decline in real output from the SPF. Consistent with the findings from the point forecast data, these probability forecasts indicate that the decline in macroeconomic uncertainty as measured from an autoregressive model is overstated. While both the average probability of a decline in output and the uncertainty surrounding future declines in output computed from an autoregressive model decrease sharply after the mid-1980's, the SPF probability forecasts exhibit no such decrease. I assess the economic significance of the overstatement in the decline of macroeconomic uncertainty in terms of its effects on forecasts of the future equity premium. These results indicate that using the decline in the total volatility of real output growth along with the standard CCAPM model overstates the decline in the future equity premium by roughly 20 percent.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2004-52.

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    Date of creation: 2004
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    Handle: RePEc:fip:fedgfe:2004-52

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    Keywords: Macroeconomics ; Uncertainty ; Forecasting;

    References

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    1. Dean Croushore, 1993. "Introducing: the survey of professional forecasters," Business Review, Federal Reserve Bank of Philadelphia, issue Nov, pages 3-15.
    2. Martin Lettau & Sydney C. Ludvigson & Jessica A. Wachter, 2004. "The Declining Equity Premium: What Role Does Macroeconomic Risk Play?," NBER Working Papers 10270, National Bureau of Economic Research, Inc.
    3. James H. Stock & Mark W. Watson, 2003. "Has the Business Cycle Changed and Why?," NBER Chapters, in: NBER Macroeconomics Annual 2002, Volume 17, pages 159-230 National Bureau of Economic Research, Inc.
    4. James H. Stock & Mark W. Watson, 1989. "New Indexes of Coincident and Leading Economic Indicators," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 351-409 National Bureau of Economic Research, Inc.
    5. Chang-Jin Kim & Charles Nelson & Jeremy Piger, 2001. "The less volatile U.S. economy: a Bayesian investigation of timing, breadth, and potential explanations," International Finance Discussion Papers 707, Board of Governors of the Federal Reserve System (U.S.).
    6. John Y. Campbell & John H. Cochrane, 1995. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," NBER Working Papers 4995, National Bureau of Economic Research, Inc.
    7. Chang-Jin Kim & Charles R. Nelson, 1999. "Has The U.S. Economy Become More Stable? A Bayesian Approach Based On A Markov-Switching Model Of The Business Cycle," The Review of Economics and Statistics, MIT Press, vol. 81(4), pages 608-616, November.
    8. Whitney K. Newey & Kenneth D. West, 1986. "A Simple, Positive Semi-Definite, Heteroskedasticity and AutocorrelationConsistent Covariance Matrix," NBER Technical Working Papers 0055, National Bureau of Economic Research, Inc.
    9. Olivier Blanchard & John Simon, 2001. "The Long and Large Decline in U.S. Output Volatility," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 32(1), pages 135-174.
    10. Lettau, Martin & Ludvigson, Sydney, 1999. "Consumption, Aggregate Wealth and Expected Stock Returns," CEPR Discussion Papers 2223, C.E.P.R. Discussion Papers.
    11. Hafer, R W & Hein, Scott E, 1985. "On the Accuracy of Time-Series, Interest Rate, and Survey Forecasts of Inflation," The Journal of Business, University of Chicago Press, vol. 58(4), pages 377-98, October.
    12. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
    13. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
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    Cited by:
    1. Antonello D'Agostino & Domenico Giannone & Paolo Surico, 2005. "(Un)Predictability and Macroeconomic Stability," Macroeconomics 0510024, EconWPA.
    2. Robert F. Martin, 2006. "The Baby Boom: Predictability in House Prices and Interest Rates," 2006 Meeting Papers 84, Society for Economic Dynamics.
    3. Fabio Canova & Luca Gambetti, 2010. "Do Expectations Matter? The Great Moderation Revisited," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(3), pages 183-205, July.
    4. Matthias Kredler, 2005. "Sector-Specific Volatility Patterns in Investment," Macroeconomics 0501016, EconWPA.
    5. Andersson, Michael K. & Karlsson, Gustav & Svensson, Josef, 2007. "The Riksbank’s Forecasting Performance," Working Paper Series 218, Sveriges Riksbank (Central Bank of Sweden).
    6. Rudebusch, Glenn D. & Williams, John C., 2009. "Forecasting Recessions: The Puzzle of the Enduring Power of the Yield Curve," Journal of Business & Economic Statistics, American Statistical Association, vol. 27(4), pages 492-503.

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