The Prewar-Postwar Output Volatility and Shock-Persistence Debate: A Closer Look and New Results

It is well established that the U.S. prewar output was more volatile and less shock-persistent than the postwar output. This is often attributed to the data interpolation employed to construct the prewar series, rather than the postwar stabilization policies and institutional changes. Our analytical results, however, indicate that commonly used linear interpolation has the opposite effect on shock persistence and volatility of a series—it reduces short-run volatility and raises shock persistence. Therefore, interpolation does not seem to explain away the observed gaps between the volatility and shock persistence of the prewar and postwar series. If anything, it may hide part of the true gap. Consequently, our results strengthen the case that the prewar-postwar difference reflects real economic changes rather than interpolation, leaving stabilization policies and institutional changes as possible explanations. Our results hold for parsimonious stationary and nonstationary time series commonly used to model macroeconomic data. Our theoretical finding is also supported by a counterfactual empirical exercise we conduct using U.S. postwar series