The heterogeneous Great Moderation

Abstract

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.