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Sources of the Great Moderation: Shocks, Frictions, 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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  • Zheng Liu & Daniel F. Waggoner & Tao Zha, 2008. "Sources of the Great Moderation: Shocks, Frictions, or Monetary Policy?," Emory Economics 0811, Department of Economics, Emory University (Atlanta).
  • Handle: RePEc:emo:wp2003:0811
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    1. Ríos-Rull, José-Víctor & Schorfheide, Frank & Fuentes-Albero, Cristina & Kryshko, Maxym & Santaeulàlia-Llopis, Raül, 2012. "Methods versus substance: Measuring the effects of technology shocks," Journal of Monetary Economics, Elsevier, pages 826-846.
    2. Mumtaz, Haroon & Zanetti, Francesco, 2012. "Neutral technology shocks and employment dynamics: results based on an RBC identification scheme," Bank of England working papers 453, Bank of England.
    3. Faia, Ester & Lechthaler, Wolfgang & Merkl, Christian, 2009. "Labor Turnover Costs, Workers' Heterogeneity, and Optimal Monetary Policy," IZA Discussion Papers 4322, Institute for the Study of Labor (IZA).
    4. Jonathan Heathcote & Kjetil Storesletten & Giovanni L. Violante, 2014. "Consumption and Labor Supply with Partial Insurance: An Analytical Framework," American Economic Review, American Economic Association, pages 2075-2126.
    5. John Tsoukala & Hashmat Khan, "undated". "Investment Shocks and the Comovement Problem," Discussion Papers 10/09, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
    6. Khan, Hashmat & Tsoukalas, John, 2011. "Investment shocks and the comovement problem," Journal of Economic Dynamics and Control, Elsevier, pages 115-130.
    7. Parantap Basu & Christoph Thoenissen, 2011. "International business cycles and the relative price of investment goods," Canadian Journal of Economics, Canadian Economics Association, vol. 44(2), pages 580-606, May.
    8. Francesco Furlanetto & Martin Seneca, 2010. "Investment-specific technology shocks and consumption," Working Paper 2010/30, Norges Bank.
    9. Giorgio E. Primiceri & Andrea Tambalotti & Alejandro Justiniano, 2009. "Investment Shocks and the Relative Price of Investment," 2009 Meeting Papers 686, Society for Economic Dynamics.
    10. Francesco Bianchi, 2013. "Regime Switches, Agents' Beliefs, and Post-World War II U.S. Macroeconomic Dynamics," Review of Economic Studies, Oxford University Press, pages 463-490.
    11. Katheryn N. Russ & Diego Valderrama, 2009. "Financial Choice in a Non-Ricardian Model of Trade," NBER Working Papers 15528, National Bureau of Economic Research, Inc.
    12. Zheng Liu & Pengfei Wang & Tao Zha, 2010. "Do credit constraints amplify macroeconomic fluctuations?," FRB Atlanta Working Paper 2010-01, Federal Reserve Bank of Atlanta.
    13. Francesco Bianchi & Leonardo Melosi, 2014. "Dormant Shocks and Fiscal Virtue," NBER Macroeconomics Annual, University of Chicago Press, vol. 28(1), pages 1-46.
    14. Alejandro Justiniano & Giorgio Primiceri & Andrea Tambalotti, 2011. "Investment Shocks and the Relative Price of Investment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 14(1), pages 101-121, January.
    15. Mohammed Dore & Roelof Makken & Erik Eastman, 2013. "The Monetary Transmission Mechanism, Non-residential Fixed Investment and Housing," Atlantic Economic Journal, Springer;International Atlantic Economic Society, pages 215-224.
    16. Zheng Liu & Pengfei Wang & Tao Zha, 2009. "Do Credit Constraints Amplify Macroeconomic Fluctuations?," Emory Economics 0910, Department of Economics, Emory University (Atlanta).
    17. José-Víctor Ríos-Rull & Frank Schorfheide & Cristina Fuentes-Albero & Maxym Kryshko & Raül Santaeulàlia-Llopis, 2009. "Methods versus Substance: Measuring the Effects of Technology Shocks on Hours," NBER Working Papers 15375, National Bureau of Economic Research, Inc.
    18. Selgin, George & Lastrapes, William D. & White, Lawrence H., 2012. "Has the Fed been a failure?," Journal of Macroeconomics, Elsevier, pages 569-596.
    19. Jambu, Marc-Antoine, 2010. "Has the Globalisation really generated more competition in OECD economies," MPRA Paper 19974, University Library of Munich, Germany.

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