![]() ![]() 4 Few disagree that monetary policy has played a large part in stabilizing inflation, and so the fact that output volatility has declined in parallel with inflation volatility, both in the United States and abroad, suggests that monetary policy may have helped moderate the variability of output as well. Economists generally agree that the 1970s, the period of highest volatility in both output and inflation, was also a period in which monetary policy performed quite poorly, relative to both earlier and later periods (Romer and Romer, 2002). Both output volatility and inflation volatility rose significantly in the 1970s and early 1980s and, as I have noted, both fell sharply after about 1984. In particular, output volatility in the United States, at a high level in the immediate postwar era, declined significantly between 19, a period in which inflation volatility was low. As Blanchard and Simon (2001) show, output volatility and inflation volatility have had a strong tendency to move together, both in the United States and other industrial countries. The historical pattern of changes in the volatilities of output growth and inflation gives some credence to the idea that better monetary policy may have been a major contributor to increased economic stability. The second class of explanations focuses on the arguably improved performance of macroeconomic policies, particularly monetary policy. ![]() 3 The increased depth and sophistication of financial markets, deregulation in many industries, the shift away from manufacturing toward services, and increased openness to trade and international capital flows are other examples of structural changes that may have increased macroeconomic flexibility and stability. Some economists have argued, for example, that improved management of business inventories, made possible by advances in computation and communication, has reduced the amplitude of fluctuations in inventory stocks, which in earlier decades played an important role in cyclical fluctuations. Explanations focusing on structural change suggest that changes in economic institutions, technology, business practices, or other structural features of the economy have improved the ability of the economy to absorb shocks. Why has macroeconomic volatility declined? Three types of explanations have been suggested for this dramatic change for brevity, I will refer to these classes of explanations as structural change, improved macroeconomic policies, and good luck. The reduction in the volatility of output is also closely associated with the fact that recessions have become less frequent and less severe. Lower volatility of output tends to imply more stable employment and a reduction in the extent of economic uncertainty confronting households and firms. Lower volatility of inflation improves market functioning, makes economic planning easier, and reduces the resources devoted to hedging inflation risks. Reduced macroeconomic volatility has numerous benefits. ![]() 1 Several writers on the topic have dubbed this remarkable decline in the variability of both output and inflation "the Great Moderation." Similar declines in the volatility of output and inflation occurred at about the same time in other major industrial countries, with the recent exception of Japan, a country that has faced a distinctive set of economic problems in the past decade. In a recent article, Olivier Blanchard and John Simon (2001) documented that the variability of quarterly growth in real output (as measured by its standard deviation) has declined by half since the mid-1980s, while the variability of quarterly inflation has declined by about two thirds. One of the most striking features of the economic landscape over the past twenty years or so has been a substantial decline in macroeconomic volatility. FRB: Speech, Bernanke-The Great Moderation-February 20, 2004Īt the meetings of the Eastern Economic Association, Washington, DC ![]()
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