Interpreting the Great Moderation: Changes in the Volatility of Economic Activity at the Macro and Micro Levels

41 Pages Posted: 25 Jul 2008

See all articles by Steven J. Davis

Steven J. Davis

University of Chicago; National Bureau of Economic Research (NBER); Hoover Institution

James A. Kahn

Yeshiva University; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: July 2008

Abstract

We review evidence on the Great Moderation together with evidence about volatility trends at the micro level to develop a potential explanation for the decline in aggregate volatility since the 1980s and its consequences. The key elements are declines in firm-level volatility and aggregate volatility - most dramatically in the durable goods sector - but with no 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.

Keywords: Great Moderation, inventories, monetary policy, volatility

JEL Classification: E20, E32

Suggested Citation

Davis, Steven J. and Kahn, James A., Interpreting the Great Moderation: Changes in the Volatility of Economic Activity at the Macro and Micro Levels (July 2008). FRB of New York Staff Report No. 334, Available at SSRN: https://ssrn.com/abstract=1166556 or http://dx.doi.org/10.2139/ssrn.1166556

Steven J. Davis

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