interpreting the great moderation changes in the volatility of economic activity at the macro and micro levels most advanced economies have experienced a striking decline in the volatility of aggregate economic activity since the early 1980s volatility reductions are evident for output and employment at the aggregate level and across most industrial sectors and expenditure categories inflation and inflation volatility have also declined dramatically previous studies offer several potential explanations for this great moderation we review evidence on the great moderation in conjunction with evidence about volatility trends at the micro level we combine the two types of evidence to develop a tentative story for important components of the aggregate volatility decline and its consequences the key ingredients are declines in firm level volatility and aggregate volatility most dramatically in the durable goods sector surprisingly this has occurred without a 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

erratum to why has u s inflation become harder to forecast the article journal of money credit and banking supplement to vol 39 no 1 february 2007 contains errors in figures 2 4 and tables 4 5 associated with a coding error in our program for estimating the uc sv model we thank ling hu of platinum grove asset management for finding this error and bringing it to our attention the corrected uc sv rows for tables 4 and 5 are given below corrected versions of figures 2 4 and corrected replication files can be found at http www princeton edu mwatson

a pure financial explanation for trade credit this paper provided a pure financial explanation for the existence of trade credit and for the values of the credit terms offered to customers two motives for extending trade credit were identified the pure operating flexibility motive arises because the opportunity to change credit policy provides the seller an efficient way to respond to fluctuations in demand this motive was eliminated from consideration in this paper by assuming constant demand the seller must hold a liquid reserve when the financial markets are imperfect and the desire to earn an excess rate of return on this reserve explains the pure financial intermediary motive for trade credit the pure financial incentive to lend this liquid reserve to customers was examined by viewing a market borrowing rate of interest that exceeds the market lending rate of interest as a hindrance to trade or equivalently as a financial market tariff this tariff imposes a wedge between the market prices paid and received for the product plus a loan and thereby inflicts a loss of surplus on the seller and buyers trade credit lending enables the seller and or the buyers to recapture at least part of this loss when the source of the tariff does not apply to direct loans to customers financial market tariffs caused by transactions costs fulfill this requirement because the trade credit lender s familiarity with its customers and product provide it with information and collection cost advantages over financial intermediaries tariffs caused by financial intermediary rents fulfill this requirement as well because the parties to a trade credit loan do not employ the services of a financial intermediary increasing opportunity costs and financial market imperfections in addition to the ones described above establish the limits of credit policy the optimal amount of accounts receivable is derived from the condition that the marginal revenue of trade credit lending is equal to the marginal cost this condition combined with factoring costs produces a unique finite optimal credit period accrual accounting for income tax purposes imposes an additional restriction because the firm is taxed on the recovery of its opportunity costs these limitations on credit policy were examined separately in this paper for clarity but they are in effect simultaneously in practice

why has u s inflation become harder to forecast we examine whether the u s rate of price inflation has become harder to forecast and to the extent that it has what changes in the inflation process have made it so the main finding is that the univariate inflation process is well described by an unobserved component trend cycle model with stochastic volatility or equivalently an integrated moving average process with time varying parameters this model explains a variety of recent univariate inflation forecasting puzzles and begins to explain some multivariate inflation forecasting puzzles as well

the role of credit in the great moderation a multivariate garch approach abstract during the great moderation financial innovation in the us increased the size and scope of credit flows supporting the growth of wealth we hypothesize that spending out of wealth came to finance a wider range of gdp components such that it smoothed gdp both these trends combined would be consistent with a decrease in the volatility of output we suggest testable implications in terms of both growth of credit and output and volatility of growth in a multivariate garch framework we test this view for home mortgages and residential investment we observe unidirectional causality in variance from total output residential investment and non residential output to mortgage lending before but not during the great moderation these findings are consistent with a role for credit dynamics in explaining the great moderation

macroeconomic forecasting and structural change the aim of this paper is to assess whether explicitly modeling structural change increases the accuracy of macroeconomic forecasts we produce real time out of sample forecasts for inflation the unemployment rate and the interest rate using a time varying coefficients var with stochastic volatility tv var for the us the model generates accurate predictions for the three variables in particular for inflation the tv var outperforms in terms of mean square forecast error all the competing models fixed coefficients vars time varying ars and the na ove random walk model these results are also shown to hold over the period commonly referred to as the great moderation

great moderation and great recession from plain sailing to stormy seas many have argued that the great recession of 2008 marks the end of the great moderation of the eighties and nineties this paper shows this is not the case through painstaking empirical analysis of the data output volatility remains subdued despite the tumult created by the great recession this nding has important implications for policymaking since a lower volatility of output the hallmark of the great moderation is associated with lower recoveries jel classication c22 e32

measuring uncertainty and its impact on the economy we propose a new framework for measuring uncertainty and its effects on the economy based on a large var model with errors whose stochastic volatility is driven by two common unobservable factors representing aggregate macroeconomic and financial uncertainty the uncertainty measures can also influence the levels of the variables so that contrary to most existing measures ours reflect changes in both the conditional mean and volatility of the variables and their impact on the economy can be assessed within the same framework moreover identification of the uncertainty shocks is simplified with respect to standard var based analysis in line with the favar approach and with heteroskedasticity based identification finally the model which is also applicable in other contexts is estimated with a new bayesian algorithm which is computationally efficient and allows for jointly modeling many variables while previous var models with stochastic volatility could only handle a handful of variables empirically we apply the method to estimate uncertainty and its effects using us data finding that there is indeed substantial commonality in uncertainty sizable effects of uncertainty on key macroeconomic and financial variables with responses in line with economic theory

unemployment dynamics across oecd countries abstract the european community and the us have experienced vastly different unemployment dynamics over the last two decades this paper investigates whether these differences are due to exposure to different shocks or reacting differently to the same shocks with the premise of a search theoretic framework and a structural var methodology the paper robustly identifies aggregate versus reallocative shocks with the exception of spain where most of the dynamics seem to be driven by reallocation it is found that most differences in unemployment dynamics arise because of differences in responses to shocks in particular the us labour market is quicker to adjust than the european community this implies that eec economies might be dynamically sclerotic even if the size of the steady state labour market flows give the impression that european labour markets are quite active various identifying assumptions additional labour supply shocks and different variables are used yet the results appear robust

business cycle stylized facts and inventory behaviour new evidence for the euro area abstract the purpose of this paper is for the first time to use business tendency survey data first to identify new facts that are useful for the interpretation of the decline in the volatility of real activity in the euro area and second to test the inventory management hypothesis as an explanation for the great moderation in europe we present stylized facts from the business tendency data on series for inventories current production current orders and expected production for the euro area emphasizing the decline in the volatility of the series further we investigate whether the decline in inventory volatility can be attributed to an endogenous change in the persistence of shocks to the accumulation dynamics of inventories or to an exogenous change in the shocks hitting the inventory optimisation process our results at euro level generally indicate that there is no evidence of a break in the inventory accumulation process on the contrary the impact of exogenous shocks on inventory volatility appears to be steadily declining over time beginning from the mid 1980s

entry in commercial banking 1962 78 the banking act of 1935 provided for greatly tightened federal regulation of entry into the bank industry in a well known study peltzman 1965 investigated whether this legislation in fact had affected the entry rate in the industry he found a significant downward shift of the intercept in his model of the relation between the entry rate and its economic determinants in the post 1935 period 1

facts and challenges from the great recession for forecasting and macroeconomic modeling this paper provides a survey of business cycle facts updated to take account of recent data emphasis is given to the great recession which was unlike most other postwar recessions in the united states in being driven by deleveraging and financial market factors we document how recessions with financial market origins are different from those driven by supply or monetary policy shocks this helps explain why economic models and predictors that work well at some times do poorly at other times we discuss challenges for forecasters and empirical researchers in light of the updated business cycle facts

explaining the great moderation it is not the shocks this paper shows that the explanation of the decline in the volatility of gdp growth since the mid eighties is not the decline in the volatility of exogenous shocks but rather a change in their propagation mechanism

business cycles synchronicity and income levels has globalisation brought us closer than ever research on business cycle linkages shows a tendency to model countries of relatively the same income levels jointly however the issue of whether these countries move along the same business cycles has not been formally investigated in the literature in this paper we take this approach and investigate whether each group of countries follows its own dynamics and is therefore subjected to the same business cycle and whether these cycles are independent of each other across income groups results indicate that high income per capita countries hics tend to be guided by stronger similarity in business cycles than countries in the middle mics and low income lics groups in search for an explanation of the business cycles synchronicity observed panel data analysis was explored the results from the robust fixed effects estimation show neither trade openness nor shocks to consumption underlie international business cycle synchronization but rather shocks to oil prices

deposit interest rate ceilings as credit supply shifters bank level evidence on the effects of regulation q abstract how did deposit interest rate ceilings an important feature of the u s regulatory regime until the mid 1980s affect individual banks lending and the transmission of monetary policy to credit i estimate the effect of deposit rate ceilings inscribed in regulation q on commercial banks credit growth using a historical bank level data set starting in 1959 banks credit growth contracted sharply when legally fixed deposit rate ceilings were binding interaction terms with monetary policy suggest that the policy impact on bank level credit growth was non linear and significantly larger when rate ceilings were in place bank size and capitalization mitigate these effects at the bank level short term interest rates exceeding the legally fixed deposit rate ceilings identify policy induced credit supply shifts that disappeared with deposit rate deregulation and thus weakened the bank lending channel substantially since the early 1980s

the time varying volatility of macroeconomic fluctuations we investigate the sources of the important shifts in the volatility of us mac roeconomic variables in the postwar period to this end we propose the esti mation of dsge models allowing for time variation in the volatility of the structural innovations we apply our estimation strategy to a large scale model of the business cycle and find that shocks specific to the equilibrium condition of investment account for most of the sharp decline in volatility of the last two decades jel c51 e32

revealing the preferences of the us federal reserve we use bayesian methods to estimate changes in us post war monetary policy in the smets and wouters model we perform the estimations by allowing for a break in monetary policy at the time of volcker s appointment as chairman this enables us to capture changes in the monetary policy regime introduced by volcker during the volcker greenspan period we find support for the assumption that monetary policy in the volcker greenspan period performed optimally under commitment our estimation strategy allows us to estimate the preferences of the us federal reserve in the volcker greenspan period where the main objective of policy appears to be inflation followed by interest rate stabilization output growth and interest rate smoothing we find that the great moderation of output growth is explained by a combination of two factors the decrease in the volatility of the structural shocks and the improved monetary policy conduct inflation stabilization however is mainly due to the change in monetary policy that took place at the beginning of volcker s mandate copyright 2010 john wiley sons ltd

the heterogeneous great moderation in this paper i show that a more accurate analysis of the great moderation leads to interesting and novel findings about macroeconomic volatility dynamics in the last decades the main empirical result of the paper is that the great moderation has diversely affected macroeconomic volatility at different horizons short run business cycle and medium run i refer to this phenomenon as the heterogeneous great moderation across frequencies i formally test these findings by defining a frequency domain structural break test that detects the presence of a break in the variance of real macroeconomic variables at different frequencies i derive its asymptotic and small sample properties and i apply it to u s macroeconomic variables to provide statistical evidence that the great moderation is mainly confined to short run fluctuations i finally use a dsge model to investigate which elements of the model can generate the heterogeneous great moderation i find that whereas just a decline of the magnitude of the shocks and a change in the monetary policy cannot replicate the stylized facts accounting for the increased persistence of the exogenous disturbances is the key feature for generating the heterogeneous great moderation

what can regulators regulate the case of bank entry previous researchers have claimed that the banking acts of 1933 and 1935 reduced the annual rate of entry of new commercial banks by as much as 50 percent between 1936 and 1962 in contrast the authors find that this legislation did not reduce bank entry rates previous studies did not account for legislative changes that reduced restrictions over branch banking and stimulated growth in the number of branches in about half the states during the 1936 62 period after accounting for these changes in branching laws it becomes clear that entry of new banks was depressed by growth in branch banks not by restrictive federal regulations copyright 1992 by ohio state university press

has monetary policy become more effective we investigate the implications of changes in the structure of the u s economy for monetary policy effectiveness estimating a vector autoregression over the pre and post 1980 periods we provide evidence of a reduced effect of monetary policy shocks in the latter period we estimate a structural model that replicates well the economy s response in both periods and perform counterfactual experiments to determine the source of the change in the monetary transmission mechanism and in the economy s volatility we find that by responding more strongly to inflation expectations monetary policy has stabilized the economy more effectively in the post 1980 period

the structural dynamics of output growth and inflation some international evidence we examine the dynamics of output growth and inflation in the us euro area and uk using a structural time varying coefficient var there are important similarities in structural inflation dynamics across countries output growth dynamics differ swings in the magnitude of inflation and output growth volatilities and persistences are accounted for by a combination of three structural shocks changes over time in the structure of the economy are limited and permanent variations largely absent changes in the volatilities of structural shocks matter

monetary policy shocks and foreign investment income evidence from a large bayesian var abstract this paper assesses the transmission of monetary policy in a large bayesian vector autoregression based on the approach proposed by banbura et al 2010 the paper analyzes the impact of monetary policy shocks in the united states and canada not only on a range of domestic aggregates trade flows and exchange rates but also foreign investment income the analysis provides three main results first a surprise monetary policy contraction has a statistically important impact on both gross and net foreign investment income flows in both countries against the background of growing foreign wealth and investment income this result provides preliminary evidence that foreign balance sheet channels might play an increasingly significant role for monetary transmission second the impact of monetary policy on foreign investment income flows differs considerably across asset categories and over time suggesting that the investment instruments and the currency denomination of a country s foreign assets and liabilities are potentially relevant for the way in which monetary policy affects the domestic economy finally the results support existing evidence on the effectiveness of large vector autoregressions and the bayesian shrinkage approach in eliminating price and exchange rate puzzles

optimal control of heteroscedastic macroeconomic models summary this paper analyses the implications of heteroscedasticity for optimal macroeconomic policy and welfare we find that changes in the variance structure driven by exogenous processes like generalized autoregressive conditional heteroscedasticity garch affect welfare but not the optimal feedback rule however changes in the variance structure driven by state dependent processes affect both we also derive certainty equivalent transformations of state dependent volatility models that allow standard quadratic dynamic programming algorithms to be employed to study optimal policy these results are illustrated numerically using a reduced form model of the us economy in which changes in volatility are driven by a garch process and the rate of inflation copyright 2015 john wiley sons ltd

spillovers to low income countries importance of systemic emerging markets this article documents the expanding economic linkages between low income countries lics and a narrow group of emerging market em leaders that have become major players in international trade and financial flows var models show that these linkages have increased the share of growth volatility that can be attributed to foreign shocks in lics dynamic panel models further analyse the impact of lic trade orientation and production structure on the sensitivity to foreign shocks the empirical results demonstrate that the elasticity of growth to trading partners growth is high for lics in three out of the five regions asia latin america and the caribbean and europe and central asia however for commodity exporting lics in sub saharan africa and the middle east terms of trade shocks and demand from the em leaders are the main channels of transmission of foreign shocks

the u s business cycle 1867 2006 a dynamic factor approach we estimate a stock watson index of economic activity to assess u s business cycle volatility since 1867 we replicate the great moderation of the 1980s and 1990s and find exceptionally low volatility also in the golden age of the 1960s postwar moderation relative to pre 1914 occurs under constant but not time varying factor loadings suggesting structural change toward more volatile sectors for comparable series the u s postwar business cycle was as volatile overall as under the classical gold standard but much less so during the great moderation and the golden age

were there regime switches in u s monetary policy working paper 2004 14 june 2004 abstract a multivariate model identifying monetary policy and allowing for simultaneity and regime switching in coefficients and variances is confronted with u s data since 1959 the best fit is with a model that allows time variation in structural disturbance variances only among models that also allow for changes in equation coefficients the best fit is for a model that allows coefficients to change only in the monetary policy rule that model allows switching among three main regimes and one rarely and briefly occurring regime the three main regimes correspond roughly to periods when most observers believe that monetary policy actually differed and the differences in policy behavior are substantively interesting though statistically ill determined the estimates imply monetary targeting was central in the early 80s but was also important sporadically in the 70s the changes in regime were essential neither to the rise in inflation in the 70s nor to its decline in the 80s jel classification e52 e47 c53 key words counterfactuals lucas critique policy rule monetary targeting simultaneity volatility model comparison i the debate over monetary policy change in an influential paper clarida gali and gertler 2000 cgg presented evidence that us monetary policy changed between the 1970 s and the 1980 s indeed that in the 70 s it was drastically worse they found that the policy rule apparently followed in the 70 s was one that when embedded in most stochastic general equilibrium models would imply non uniqueness of the equilibrium and hence vulnerability of the economy to sunspot fluctuations of arbitrarily large size their estimated policy rule for the later period on the other hand eliminated this indeterminacy these results are a possible explanation of the volatile and rising inflation of the 70 s and of its subsequent decline the cgg analysis has two important weaknesses one is that it fails to account for stochastic volatility us macroeconomic variables and particularly the federal funds rate have gone through periods of tranquility and of agitation with forecast error variances varying greatly from period to period ignoring such variation does not lead to inconsistent estimates of model parameters when the forecasting equations themselves are constant but it strongly biases toward a finding of changed parameters tests of the stability of the forecasting equations the other weakness is that the cgg analysis rests on powerful and implausible identifying assumptions they require that we accept that the response of the monetary authority to expected future inflation and output does not depend on the recent history of inflation money growth or output it is hard to understand why this should be so especially in the 70 s when monetarism was a prominent theme in policy debates congress was requiring reports from the fed of projected time paths of monetary aggregates and financial markets were reacting sensitively to weekly money supply numbers the requirement for existence and uniqueness of equilibrium in dynamic models is that the monetary policy rule show a more than unit response of interest rates to the sum of the logs of all nominal variables that appear on the right hand side of the reaction function if we force a particular measure of expected future inflation to proxy for all the nominal variables that actually appear independently in the reaction function we are bound to get distorted conclusions on the one hand because expected future inflation will be a noisy measure of the full set of nominal influences on policy we might get downward bias in our estimates from the usual errorsin variables effect on the other hand to the extent that expected future inflation like most expected future values shows less variation than current nominal variables we could find a mistaken scaling up of coefficients

structural changes in the us economy is there a role for monetary policy this paper investigates the contribution of monetary policy to the changes in output growth and inflation dynamics in the us we identify a policy shock and a policy rule in at ime varying coefficients var using robust sign restrictions the transmission of policy shocks has been relatively stable the variance of the policy shock has decreased over time but policy shocks account for a small fraction of the level and of the variations in inflation and output growth volatility and persistence we find little evidence of a significant increase in the long run response of the interest rate to inflation a more aggressive inflation policy in the 1970s would have produced large output growth costs