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What's so Great about the Great Moderation? A Multi-Country Investigation of Time-Varying Volatilities of Output Growth and Inflation

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Author Info

  • John W. Keating

    (Department of Economics, The University of Kansas)

  • Victor J. Valcarcel

    (Department of Economics, Texas Tech University)

Abstract

Changes in volatility of output growth and inflation are examined for eight countries with at least 140 years of uninterrupted data. Time-varying parameter vector autoregressions are used to estimate standard deviations of each variable. Both volatilities rise quickly with World War I and its aftermath, stay relatively high until the end of World War II, and then drop rapidly until the mid- to late 1960s. This Postwar Moderation typically yields the largest decline in output growth volatilities. For all countries, volatilities of both output growth and inflation fall more during this Postwar Moderation than during the Great Moderation, and often the difference is huge. Both volatilities typically reach their lowest levels following the Great Moderation. The Great Moderation often counteracts an increase in volatility that took place in the 1970s, particularly for inflation. In nearly all the countries in our sample, the recent financial crisis has eliminated the stability gains associated with the Great Moderation, and sometimes it has even eroded gains made during the Postwar Moderation. Periods in which a fixed exchange rate system was widespread are associated with relatively low volatilities for both variables. Based on our structural VAR identification, permanent shocks to output account for nearly all of the fluctuations in the volatility of output growth while shocks that have only a temporary effect on output explain most of the fluctuations in inflation volatility. These last two findings suggest that changes in the volatility for each variable are primarily driven by a fundamentally different type of disturbance.

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Bibliographic Info

Paper provided by University of Kansas, Department of Economics in its series WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS with number 201204.

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Length: 37 pages
Date of creation: Feb 2012
Date of revision:
Handle: RePEc:kan:wpaper:201204

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Keywords: The Great Moderation; The Postwar Moderation; stochastic volatility; permanent-transitory shock decompositions; Markov Chain Monte Carlo; structural vector autoregressions.;

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References

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  1. Guido Ascari & Tiziano Ropele, 2007. "Trend Inflation, Taylor Principle and Indeterminacy," Kiel Working Papers 1332, Kiel Institute for the World Economy.
  2. James M. Nason & Gregor W. Smith, 2008. "Great moderations and U.S. interest rates: unconditional evidence," Working Paper 2008-01, Federal Reserve Bank of Atlanta.
  3. Jon Faust & Eric M. Leeper, 1994. "When do long-run identifying restrictions give reliable results?," International Finance Discussion Papers 462, Board of Governors of the Federal Reserve System (U.S.).
  4. Luca Gambetti & Jordi Gal�, 2009. "On the Sources of the Great Moderation," American Economic Journal: Macroeconomics, American Economic Association, vol. 1(1), pages 26-57, January.
  5. Keating, John & Valcarcel, Victor, 2012. "Greater moderations," Economics Letters, Elsevier, vol. 115(2), pages 168-171.
  6. Kilian, Lutz, 2011. "Structural Vector Autoregressions," CEPR Discussion Papers 8515, C.E.P.R. Discussion Papers.
  7. Stephen G. Cecchetti & Alfonso Flores-Lagunes & Stefan Krause, 2006. "Assessing the Sources of Changes in the Volatility of Real Growth," NBER Working Papers 11946, National Bureau of Economic Research, Inc.
  8. Peter M. Summers, 2005. "What caused the Great Moderation? : some cross-country evidence," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 5-32.
  9. John W. Keating & Victor J. Valcarcel, 2012. "The Time Varying Effects of Permanent and Transitory Shocks to Real Output," WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS 201203, University of Kansas, Department of Economics.
  10. 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.
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