Friday, August 1, 2008

The "Great Moderation" at the State Level

Michael Owyang, Jeremy Piger, and Howard Wall have a paper that takes a fresh look at the "Great Moderation", the reduction in aggregate macroeconomic volatility since the early 1980s. This Great Moderation has received a lot of attention--including from this blog(here and here)--with a lot of it directed to explaining why the volatility has declined . These authors make a novel contribution to this literature by looking at this issue from the state level. Their paper, titled "A State-Level Analysis of the Great Moderation", points to better monetary policy as a key factor behind the reduced macroeconomic volatility. Here are the authors in their own words:

This paper documented the Great Moderation at the state level and found significant heterogeneity in the timing and magnitude of states’ structural breaks. Specifically, we found that 38 states experienced a structural break and that 14 states had breaks that occurred at least three years before or after the aggregate break, which we place at September 1984. The states for which we found weak or little evidence of a break tended to be along the Atlantic coast.

Typically, when macroeconomists are looking for explanations for the Great Moderation, they have only the single aggregate occurrence with which to work. As a result, severalhypotheses have gained support on the basis of temporal coincidence between various events or trends and this single volatility reduction. Unfortunately for this approach, however, a surfeit of events occurred alongside the Great Moderation, so it is difficult to sort out the many theoretically plausible explanations. Our set of state-level great moderations might, therefore, be useful in sorting through the various hypotheses.

Of the five main hypotheses that have been put forth, our results suggest that four of them—the inventory, good-luck, banking deregulation, and demography hypotheses—are implausible because they are statistically inconsistent with the state-level pattern of structural breaks. On the other hand, we found that the monetary hypothesis remains a plausible explanation of the Great Moderation in that it is not inconsistent with the state-level experience.

You can read the rest of their paper here.

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