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Macroeconomic volatility, predictability and uncertainty in the Great Moderation: evidence from the survey of professional forecasters

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  • Sean D. Campbell

Abstract

An emerging and influential literature finds a large and significant decline in macroeconomic volatility since the middle of the 1980's. In this paper, I examine the extent to which the decline in annual and quarterly real output volatility since the onset of this period of Great Moderation can be attributed to changes in macroeconomic uncertainty and macroeconomic predictability. I use point forecasts of future real output growth from the Survey of Professional Forecasters (SPF) between 1969 and 2003 as a proxy for the predictable component of real output growth. The results indicate that declining predictability has played a significant role in the Great Moderation. Prior to the Great Moderation, professional forecasts explained roughly 30 percent of the variance in output growth. Post-moderation, the predictive ability of professional forecasts quickly vanished. This decline in predictability implies that interpreting the decline in the volatility of output shocks identified from a fixed parameter autoregressive model overstates the decline in macroeconomic uncertainty by between 20-40 percent. I also examine forecasts of the probability of a decline in real output from the SPF. Consistent with the findings from the point forecast data, these probability forecasts indicate that the decline in macroeconomic uncertainty as measured from an autoregressive model is overstated. While both the average probability of a decline in output and the uncertainty surrounding future declines in output computed from an autoregressive model decrease sharply after the mid-1980's, the SPF probability forecasts exhibit no such decrease. I assess the economic significance of the overstatement in the decline of macroeconomic uncertainty in terms of its effects on forecasts of the future equity premium. These results indicate that using the decline in the total volatility of real output growth along with the standard CCAPM model overstates the decline in the future equity premium by roughly 20 percent.

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  • Sean D. Campbell, 2004. "Macroeconomic volatility, predictability and uncertainty in the Great Moderation: evidence from the survey of professional forecasters," Finance and Economics Discussion Series 2004-52, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2004-52
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    References listed on IDEAS

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    Cited by:

    1. Antonello D'Agostino & Domenico Giannone & Paolo Surico, 2005. "(Un)Predictability and Macroeconomic Stability," Macroeconomics 0510024, University Library of Munich, Germany.
    2. Fabio Canova & Luca Gambetti, 2010. "Do Expectations Matter? The Great Moderation Revisited," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(3), pages 183-205, July.
    3. Robert F. Martin, 2005. "The baby boom: predictability in house prices and interest rates," International Finance Discussion Papers 847, Board of Governors of the Federal Reserve System (U.S.).
    4. Mirdala, Rajmund & Svrčeková, Aneta & Semančíková, Jozefína, 2015. "On the Relationship between Financial Integration, Financial Liberalization and Macroeconomic Volatility," MPRA Paper 66143, University Library of Munich, Germany.
    5. Rudebusch, Glenn D. & Williams, John C., 2009. "Forecasting Recessions: The Puzzle of the Enduring Power of the Yield Curve," Journal of Business & Economic Statistics, American Statistical Association, vol. 27(4), pages 492-503.
    6. Stephen Morris & Hyun Song Shin, 2005. "Central Bank Transparency and the Signal Value of Prices," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 36(2), pages 1-66.
    7. Matthias Kredler, 2005. "Sector-Specific Volatility Patterns in Investment," Macroeconomics 0501016, University Library of Munich, Germany.
    8. Andersson, Michael K. & Karlsson, Gustav & Svensson, Josef, 2007. "The Riksbank’s Forecasting Performance," Working Paper Series 218, Sveriges Riksbank (Central Bank of Sweden).

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