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Interpreting the Great Moderation: changes in the volatility of economic activity at the macro and micro Levels

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  • Steven J. Davis
  • James A. Kahn

Abstract

We review evidence on the Great Moderation together with evidence about volatility trends at the micro level to develop a potential explanation for the decline in aggregate volatility since the 1980s and its consequences. The key elements are declines in firm-level volatility and aggregate volatility - most dramatically in the durable goods sector - but with no decline in household consumption volatility and individual earnings uncertainty. Our explanation for the aggregate volatility decline stresses improved supply-chain management, particularly in the durable goods sector, and, less important, a shift in production and employment from goods to services. We provide evidence that better inventory control made a substantial contribution to declines in firm-level and aggregate volatility. Consistent with this view, if we look past the turbulent 1970s and early 1980s, much of the moderation reflects a decline in high-frequency (short-term) fluctuations. While these developments represent efficiency gains, they do not imply (nor is there evidence for) a reduction in economic uncertainty faced by individuals and households.>

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 334.

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Date of creation: 2008
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Handle: RePEc:fip:fednsr:334

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Keywords: Business cycles ; Consumption (Economics) ; Durable goods; Consumer ; Service industries ; Households - Economic aspects;

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