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Fortune or Virtue: Time-Variant Volatilities Versus Parameter Drifting in U.S. Data

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  • Jesús Fernández-Villaverde

    ()
    (Department of Economics, University of Pennsylvania)

  • Pablo Guerrón-Quintana

    ()
    (Federal Reserve Bank of Philadelphia)

  • Juan F. Rubio-Ramírez

    ()
    (Department of Economics, Duke University)

Abstract

This paper compares the role of stochastic volatility versus changes in monetary policy rules in accounting for the time-varying volatility of U.S. aggregate data. Of special interest to us is understanding the sources of the great moderation of business cycle fluctuations that the U.S. economy experienced between 1984 and 2007. To explore this issue, we build a medium-scale dynamic stochastic general equilibrium (DSGE) model with both stochastic volatility and parameter drifting in the Taylor rule and we estimate it non-linearly using U.S. data and Bayesian methods. Methodologically, we show how to confront such a rich model with the data by exploiting the structure of the high-order approximation to the decision rules that characterize the equilibrium of the economy. Our main empirical findings are: 1) even after controlling for stochastic volatility (and there is a fair amount of it), there is overwhelming evidence of changes in monetary policy during the analyzed period; 2) however, these changes in monetary policy mattered little for the great moderation; 3) most of the great performance of the U.S. economy during the 1990s was a result of good shocks; and 4) the response of monetary policy to inflation under Burns, Miller, and Greenspan was similar, while it was much higher under Volcker.

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Bibliographic Info

Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 10-015.

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Length: 73 pages
Date of creation: 15 Apr 2010
Date of revision:
Handle: RePEc:pen:papers:10-015

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Keywords: DSGE models; Stochastic volatility; Parameter drifting; Bayesian methods;

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  2. S. Boragan Aruoba & Jesus Fernandez-Villaverde & Juan Francisco Rubio-Ramirez, 2003. "Comparing solution methods for dynamic equilibrium economies," Working Paper, Federal Reserve Bank of Atlanta 2003-27, Federal Reserve Bank of Atlanta.
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  8. Jesus Fernandez-Villaverde & Pablo Guerron-Quintana & Juan F. Rubio-Ramirez & Martin Uribe, 2011. "Risk Matters: The Real Effects of Volatility Shocks," American Economic Review, American Economic Association, American Economic Association, vol. 101(6), pages 2530-61, October.
  9. Christopher A. Sims & Tao Zha, 2006. "Were There Regime Switches in U.S. Monetary Policy?," American Economic Review, American Economic Association, American Economic Association, vol. 96(1), pages 54-81, March.
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  15. Jesús Fernández-Villaverde & Pablo Guerrón-Quintana & Juan F. Rubio-Ramírez, 2010. "Reading the Recent Monetary History of the U.S., 1959-2007," PIER Working Paper Archive, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania 10-016, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
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  19. Jordi Galí & Luca Gambetti, 2006. "On the sources of the Great Moderation," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 1041, Department of Economics and Business, Universitat Pompeu Fabra, revised Jun 2007.
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  22. Fernandez-Villaverde, Jesus & Rubio-Ramirez, Juan F., 2006. "Solving DSGE models with perturbation methods and a change of variables," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 30(12), pages 2509-2531, December.
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