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Economic SYNOPSES
short essays and reports on the economic issues of the day
2003 ■ Number 24

The Less Volatile U.S. Economy
Hui Guo

1

Stock, James and Watson, Mark. “Has the Business Cycle Changed and Why?” in
Mark Gertler and Kenneth Rogoff, eds., NBER Macroeconomics Annual, 2002.
Cambridge, MA: MIT Press, pp. 159-218.

Rolling Standard Deviation of GDP Growth:
1962:Q2 to 2003:Q2
Percent
0.06

0.04

0.02

Views expressed do not necessarily reflect official positions of the Federal Reserve System.

research.stlouisfed.org

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02
:Q
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97
:Q
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19
92
:Q
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87
:Q
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82
:Q
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19
77
:Q
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19
72
:Q
2

0.00
19
67
:Q
2

O

they acknowledge that their conclusions are tentative and
are open to further investigation.
The fact that U.S. output growth is more stable now than
it was two decades ago has important implications in interpreting economic data. For example, in the 1970s, changes
in annualized GDP growth that seem large by today’s standards were, back then, within one standard deviation of the
mean and thus policymakers could consider them noise. In
contrast, a shock to output growth of a similar magnitude
today would be cause for believing that the economy might
be near a business cycle turning point and would be more
likely to elicit a prompt response from monetary policymakers. Perhaps for this reason, Federal Reserve policymakers began cutting the federal funds rate aggressively in
January 2001, based on a slowing economy that would not
actually enter a recession until March 2001. ■

19
62
:Q
2

bservers of the economy have clearly documented
that U.S. aggregate output has become much less
volatile since the early 1980s. The accompanying
chart plots the annualized standard deviation of quarterly
growth of real gross domestic product (GDP) using a 60quarter rolling window. The value corresponding to 1962:Q2
is the standard deviation of GDP growth between 1947:Q3
and 1962:Q2, for example. The downward movement in
output volatility is particularly pronounced after 1984: The
standard deviation of economic growth declined sharply
from over 4 percent to about 2 percent in recent years.
Economists have put forth three explanations why output
growth may have become more stable in the past 20 years.
One focuses on the conduct of monetary policy and the
accompanying decline in inflation. Prior to the early 1980s,
the Federal Reserve relied at times on recessions to rein in
inflation. Since then, the Federal Reserve has been proactive
in keeping inflation contained. Another explanation is that
the U.S. economy simply has enjoyed good fortune in that
there have been, for example, fewer tumultuous oil price
shocks, which can cause volatility in economic activity. The
third explanation suggests that improvements in inventory
management are important for understanding the reduction in volatility. That is, while the durable goods sector
has experienced a dramatic decline in output volatility in
the past two decades, final sales of durable goods have
seen only a moderate decline in volatility. Therefore,
durable goods inventories—the difference between production and final sales—account for a substantial reduction in output variability in the durable goods sector and
in the aggregate economy.
Stock and Watson (2002) conduct a comprehensive
analysis on this issue and provide some insights on the
relative importance of the three hypotheses in explaining
the decline in output volatility.1 Their results indicate
that improved monetary policy could account for 20 to
30 percent of the volatility reduction and that smaller
shocks probably account for most of the rest. However,