What's so Great about the Great Moderation? A Multi-Country Investigation of Time-Varying Volatilities of Output Growth and Inflation

Changes in volatility of output growth and inflation are examined for eight countries with at least 140 years of uninterrupted data. Time-varying parameter vector autoregressions are used to estimate standard deviations of each variable. Both volatilities rise quickly with World War I and its aftermath, stay relatively high until the end of World War II, and then drop rapidly until the mid- to late 1960s. This Postwar Moderation typically yields the largest decline in output growth volatilities. For all countries, volatilities of both output growth and inflation fall more during this Postwar Moderation than during the Great Moderation, and often the difference is huge. Both volatilities typically reach their lowest levels following the Great Moderation. The Great Moderation often counteracts an increase in volatility that took place in the 1970s, particularly for inflation. In nearly all the countries in our sample, the recent financial crisis has eliminated the stability gains associated with the Great Moderation, and sometimes it has even eroded gains made during the Postwar Moderation. Periods in which a fixed exchange rate system was widespread are associated with relatively low volatilities for both variables. Based on our structural VAR identification, permanent shocks to output account for nearly all of the fluctuations in the volatility of output growth while shocks that have only a temporary effect on output explain most of the fluctuations in inflation volatility. These last two findings suggest that changes in the volatility for each variable are primarily driven by a fundamentally different type of disturbance.