Great Moderation Research Articles

A quasi-Bayesian local likelihood approach to time varying parameter VAR models

The paper establishes a quasi-Bayesian local likelihood (QBLL) estimation methodology for a multivariate model with time varying parameters. The asymptotic validity of the resulting quasi-posterior distributions of the drifting parameters is proven in general and, in the special case of a Gaussian VAR model, a closed form time varying Normal-Wishart expression for the quasi-posterior distribution of the parameters is provided. In addition, this paper develops several Gibbs algorithms, which can sample from a VAR model with a mixture of time varying and time invariant parameters. The proposed estimators differ from existing state space approaches to VAR models in that they estimate parameter time variation nonparametrically, without imposing parametric stochastic processes on the parameters. The QBLL estimators are robust to misspecification of the state equation and exhibit good finite sample performance, even when compared to correctly specified parametric state space models, as illustrated by a Monte Carlo exercise. In addition, we demonstrate that the QBLL approach provides a remedy to the ‘curse of dimensionality’ by accommodating large dimensional VAR systems and delivers improvements in the out-of-sample forecasts of key macroeconomic variables. Finally, the paper makes an empirical contribution to the literature on changing inflation dynamics in the U.S., presenting evidence of a fall in inflation persistence and volatility during the Great Moderation period.

The decline in volatility in the US economy. A historical perspective

Abstract In this paper, we analyse the volatility of US GDP growth using quarterly series starting in 1875. We find structural breaks in volatility at the end of World War II and at the beginning of the Great Moderation period. We show that the Great Moderation volatility reduction is only linked to changes in expansions, whereas that after World War II is due to changes in both expansions and recessions. We also propose several methodologies to date the US business cycle in this long period. We find that taking volatility into account improves the characterization of the business cycle.

Financial and economic development link in transitional economies: a spectral Granger causality analysis 1991?2017

Research background: The relationship between financial development and economic growth has been attracting attention in the field of economics since the times of the ?great moderation?. Previous empirical studies still fail to put forward a general conclusion on whether and how financial development affects economic growth. This is particularly true due to the lack of empirical research on the matter in question for countries in transition.
 Purpose of the article: This study aims to contribute to bridging the gap in the financial development-growth nexus in transitional economies. Understanding the mechanism behind financial development and economic growth should assist policymakers in the design of efficient economic policies or avoiding/alleviating financial cycles.
 Methods: Using Granger causality test in frequency domain, which shows to have more power over standard time domain Granger causality test, as well as gross domestic product (GDP) and the monetary base (M2 ? intermediate money), we investigated the finance-growth relationship in 19 Central, East, and Southeast European countries (CESEE) from 1991 to 2017.
 Findings & Value added: Study results show that financial development is important for growth in CESEE countries, thus supporting the ?supply-leading? theories in general for countries in the sample. Our findings indicate that the relationship between financial development and economic growth exists in CESEE countries (with one exception ? the Czech Republic) ranging from unidirectional (Albania, Bosnia and Hercegovina, Belarus, Estonia, Macedonia, Russia, Turkey), to bi-directional spectral Granger causality (Bulgaria, Croatia, Hungary, Kazakhstan, Latvia, Lithuania, Poland, Romania, Slovenia, Slovakia, Ukraine).

Introduction to the special issue on sovereign debt restructuring

After the ‘wasted decade’ of the Latin American debt crisis of the 1980s, and the long-running saga following Argentine default in 2001, sovereign debt crises were widely regarded as a feature of ‘emerging market’ economies, but not for ‘advanced economies’, which had been enjoying a period of macroeconomic stability since the mid-1980s. That illusion was shattered when the period known as the Great Moderation ended abruptly in the financial crisis of 2008/9 and problems of sovereign debt management spread across Europe. Adverse speculation in the Eurozone pushed interest rates on the sovereign debt of Italy and Spain to unsustainable levels in 2012,1 for example; with contagion leading to substantial Greek default soon thereafter.

Non Linear Economic Time Series as a Testbed for Dynamic Macro Models

This is a short exercise in using nonlinear time series analysis (NLTS) to assess the fit of a dynamic nonlinear macro economic process, the Goodwin model, against “realworld” nonlinear time series. The methodology follows the approach developed by Huffaker (2015 and variously) 1 After simulating the Goodwin model and generating plausible time series and an attractor a topologically equivalent attractor is extracted from a single dimension (unemployment) from the Goodwin model. Real US unemployment data is then subjected to SSA analysis to extract a signal from any background “noise” and this signal is then subject to time delay embedding. The attractor resulting from the SSA/Takens process to US unemployment data is topologically equivalent to the attractor from the Goodwin / Predator Prey phase portrait. This primae facie, suggests that the (assumed “black box”) nonlinear economic process which generated these statistics could well have had Goodwin characteristics. The solution is both a limit cycle but also the amplitude (ratio of profitability and unemployment) suddenly increases. This probably reflects that the time series covers the “great moderation” and the subsequent 07/08 crash. This is also a characteristic of more complex nonlinear models like Keen (1997) and suggests that a similar exercise with Keens model and private debt statistics would be interesting.

New dynamics of consumption and output

Since the mid-1980s, the volatility of major macro variables has decreased remarkably, known as the Great Moderation. Even though a great deal of literature addresses the sources of the Great Moderation, its association with potential changes in the dynamics of consumption or output has not been investigated rigorously. This paper reports two empirical findings: i) a faster adjustment of output to changes in its long-run random walk component and ii) a faster adjustment of consumption to changes in permanent income (as approximated by the random walk component of real output) since the mid-1980s. Our interpretation is that a faster diffusion of technology shocks induced by improved information technology may be responsible for the former. In the presence of precautionary savings, a change in the consumer behavior induced by lower uncertainty about future income may be responsible for the latter. The change in output dynamics itself may also be responsible for the change in consumer behavior, as implied by Deaton (1991).

Money supply, output gap and economic fluctuations: evidence from quarterly data in China

Considering the endogenous structure of the aggregate supply curve, Okun's law, and the monetary output effect, this paper calculates the Chinese quarterly output gap between 1995Q4 and 2017Q2 using an SVAR model based on the inflation rate, real output, the unemployment rate and M2. Then, we reveal the influence of the time-varying characteristic on the real output using a TVP-SVAR-SV model. First, China's economy has experienced four rounds of fluctuations since 1995, and the fluctuations became stationary after 2011Q1, which is consistent with the main feature of 'great moderation'. Second, there was an asymmetric relationship between the volatility of output and money supply after 2000Q4, and the anti-Tobin effect became obvious after 2003. The shock of inflation aggravated the negative impact on output. Third, the output effect of easy monetary policy sharply decreased, and the response cycle shortened following the global financial crisis. Therefore, stimulus policy should be implemented cautiously.

Money supply, output gap and economic fluctuations: evidence from quarterly data in China

Considering the endogenous structure of the aggregate supply curve, Okun's law, and the monetary output effect, this paper calculates the Chinese quarterly output gap between 1995Q4 and 2017Q2 using an SVAR model based on the inflation rate, real output, the unemployment rate and M2. Then, we reveal the influence of the time-varying characteristic on the real output using a TVP-SVAR-SV model. First, China's economy has experienced four rounds of fluctuations since 1995, and the fluctuations became stationary after 2011Q1, which is consistent with the main feature of 'great moderation'. Second, there was an asymmetric relationship between the volatility of output and money supply after 2000Q4, and the anti-Tobin effect became obvious after 2003. The shock of inflation aggravated the negative impact on output. Third, the output effect of easy monetary policy sharply decreased, and the response cycle shortened following the global financial crisis. Therefore, stimulus policy should be implemented cautiously.

Gone With the Vol: A Decline in Asset Return Predictability During the Great Moderation

We document a significant shift in the comovement of asset returns and macroeconomic volatility during the Great Moderation. Strong U.S. stock and bond return predictability from several macroeconomic volatility series before 1982 was followed by a significant predictability decline during the Great Moderation (1982-2008). These findings are robust to alternative empirical specifications and out-of-sample tests. In a calibrated time-varying-volatility equilibrium model, the predictability decline is consistent with changes in monetary policy and shock dynamics. A stronger policy response to inflation and lower cost-push shock variance reduce the sensitivity of macroeconomic variables and asset returns to a persistent volatility factor, explaining the lower predictability. The results contribute to examine macroeconomic volatility as a driver of expected asset returns, and identify sources of the Great Moderation using asset price dynamics.

Monetary Policy, Inflation Target and the Great Moderation: An Empirical Investigation

This paper compares the empirical fit of a Taylor rule featuring constant versus time-varying inflation target by estimating a Generalized New Keynesian model under positive trend inflation while allowing for indeterminacy. The estimation is conducted over two different periods covering the Great Inflation and the Great Moderation. We find that the rule embedding time variation in target inflation turns out to be empirically superior and determinacy prevails in both sample periods. Counterfactual simulations point toward both `good policy' and `good luck' as drivers of the Great Moderation. We find that better monetary policy, both in terms of a more active response to inflation gap and a more anchored inflation target, has resulted in the decline in inflation gap volatility and predictability. In contrast, the reduction in output growth variability is mainly explained by reduced volatility of technology shocks.

Discussion

Discussion

Normality tests for latent variables

We exploit the rationale behind the Expectation Maximization algorithm to derive simple to implement and interpret LM normality tests for the innovations of the latent variables in linear state space models against generalized hyperbolic alternatives, including symmetric and asymmetric Student ts. We decompose our tests into third and fourth moment components, and obtain one‐sided likelihood ratio analogues, whose asymptotic distribution we provide. When we apply our tests to a common trend model which combines the expenditure and income versions of US aggregate real output to improve its measurement, we reject normality if the sample period extends beyond the Great Moderation.

The Struggle Toward Macroeconomic Stability: An Analytical Essay

This essay offers an economic-history perspective of the long struggle toward macroeconomic stability in Israel. The purpose is to provide a broad analytical overview of major exogenous shocks and shifts in macroeconomic policy and institutions in Israel from the 1977–85 great inflation to the global financial crisis, and the effects of those shifts on long-term growth, inflation, the business cycle, the flattening of the Phillips curve, and other related economic developments. The paper addresses three main topics. The first one is the political economics of the hyperinflation crisis, its crushing by a national-unity coalition, and its impact on subsequent reform of financial and monetary institutions. Inflation’s history points to the weak foundation of the Modern Monetary Theory, or MMT, which argues that a country borrowing in its own currency can finance fiscal stimulus by printing money in a persistent way. Second is the impact of globalization on economic activity, inflation, and the Phillips curve during the “great Moderation” period. The third is Israel’s relatively robust performance during the 2008 global crisis, the role of the financial sector stance, and the central bank foreign exchange market intervention policies.

The business cycle is alive and well

Have the dynamic relations among macro variables changed markedly since the financial crisis? A dynamic factor model provides consistent evidence of stability across 248 variables The Great Moderation appears to be ongoing; you cannot reject the hypothesis that the standard deviation of four-quarter GDP growth is the same over 1984–2007 and over 2008–2018. Even so, the apparent slower GDP growth trend implies a substantial probability that a recession may start in the next 2 years, even not adding the risk that some large unprecedented negative event may occur. Because of low interest rates and already-large deficits, the ability of Congress and the Fed to mitigate the effects of a recession are historically constrained.

Asymmetry, Complementarities, and State Dependence in Federal Reserve Forecasts

AbstractForecasts are a central component of policymaking; the Federal Reserve's forecasts are published in a document called the Greenbook. Previous studies of the Greenbook's inflation forecasts have found them to be rationalizable but asymmetric if considering particular subperiods, for example, before and after the Volcker appointment. In these papers, forecasts are analyzed in isolation, assuming policymakers value them independently. We analyze the Greenbook forecasts in a framework in which the forecast errors for different variables are allowed to interact. We find that allowing the losses to interact makes the unemployment forecasts virtually symmetric, the output forecasts symmetric prior to the Volcker appointment, and the inflation forecasts symmetric after the onset of the Great Moderation.

Bayesian forecast combination in VAR-DSGE models

We evaluate the performance of individual and combination forecasts produced by Bayesian vector autoregressions (Bayesian VARs) with economic and/or non-economic information. In particular, we conduct an out-of-sample forecasting experiment using Bayesian VARs with statistical and/or DSGE prior(s) over two subsamples, representing the so-called “Great Inflation” and “Great Moderation” periods, respectively. Our main findings are summarized as follows. First, in most cases, the inclusion of prior information, either statistical or economic prior(s), improves the accuracy of point forecasts produced by the Bayesian VARs, relative to the ARMA(1,1) benchmark. Second, forecast combination helps to produce unbiased forecasts in most cases. Moreover, it significantly improves the forecast accuracy of the macro-econometric models, especially during the “Great Moderation” period. Third, the selection of the weighting scheme in forecast combination, simple averaging or Bayesian model averaging (BMA), does not affect the conclusions made above. Finally, partially in line with the recent literature, we find a positive relationship between the persistence of inflation and its relative forecast accuracy at the four-quarter horizon.

An empirical investigation of direct and iterated multistep conditional forecasts

SummaryWhen constructing unconditional point forecasts, both direct and iterated multistep (DMS and IMS) approaches are common. However, in the context of producing conditional forecasts, IMS approaches based on vector autoregressions are far more common than simpler DMS models. This is despite the fact that there are theoretical reasons to believe that DMS models are more robust to misspecification than are IMS models. In the context of unconditional forecasts, Marcellino et al. (Journal of Econometrics, 2006, 135, 499–526) investigate the empirical relevance of these theories. In this paper, we extend that work to conditional forecasts. We do so based on linear bivariate and trivariate models estimated using a large dataset of macroeconomic time series. Over comparable samples, our results reinforce those in Marcellino et al.: the IMS approach is typically a bit better than DMS with significant improvements only at longer horizons. In contrast, when we focus on the Great Moderation sample we find a marked improvement in the DMS approach relative to IMS. The distinction is particularly clear when we forecast nominal rather than real variables where the relative gains can be substantial.

The signaling effect of raising inflation

This paper argues that central bankers should temporarily raise inflation when anticipating liquidity traps to ensure the credibility of otherwise time-inconsistent forward guidance policies. As stable inflation in normal times either stems from central bankers' desire to maintain credibility or from aversion to inflation, the private sector is unable to infer the central banker's willingness to follow through on promises from observing stable inflation, jeopardizing the efficiency of forward guidance policy. We show that this signaling motive can justify temporary deviations of inflation from target well above 2%, but also that the low inflation volatility during the Great Moderation was insufficient to ensure fully efficient forward guidance when needed.

Time-varying asymmetry and tail thickness in long series of daily financial returns

Abstract We demonstrate that analysis of long series of daily returns should take into account potential long-term variation not only in volatility, but also in parameters that describe asymmetry or tail behaviour. However, it is necessary to use a conditional distribution that is flexible enough, allowing for separate modelling of tail asymmetry and skewness, which requires going beyond the skew-t form. Empirical analysis of 60 years of S&P500 daily returns suggests evidence for tail asymmetry (but not for skewness). Moreover, tail thickness and tail asymmetry is not time-invariant. Tail asymmetry became much stronger at the beginning of the Great Moderation period and weakened after 2005, indicating important differences between the 1987 and the 2008 crashes. This is confirmed by our analysis of out-of-sample density forecasting performance (using LPS and CRPS measures) within two recursive expanding-window experiments covering the events. We also demonstrate consequences of accounting for long-term changes in shape features for risk assessment.

Financial Frictions, Financial Shocks, and Aggregate Volatility

I revisit the Great Inflation and the Great Moderation for nominal and real variables. I document that while financial price variables follow such a pattern; financial quantity variables experience a continuous immoderation. A model with financial frictions and financial shocks allowing for structural breaks in the size of shocks and the institutional framework is estimated. The paper shows that while the Great Inflation was driven by bad luck, the Great Moderation is mostly due to better financial institutions. Financial shocks arise as relevant drivers of US business cycle fluctuations.