Has the Business Cycle Changed and Why?

From 1960 to 1983, the standard deviation of annual growth rates in real GDP in the United States was 2.7 percent. From 1984 to 2001, the corresponding standard deviation was 1.6 percent. This paper investigates this large drop in the cyclical volatility of real economic activity. The paper has two objectives. The first is to provide a comprehensive characterization of the decline in volatility using a large number of US economic time series and a variety of methods designed to describe time-varying time-series processes. In so doing, the paper reviews the literature on the moderation and attempts to resolve some of its disagreements and discrepancies. The second objective is to provide new evidence on the quantitative importance of various explanations for this "great moderation." Taken together, we estimate that the moderation in volatility is attributable to a combination of improved policy (20-30 percent), identifiable good luck in the form of productivity and commodity price shocks (20-30 percent), and other unknown forms of good luck that manifest themselves as smaller reduced-form forecast errors (40-60 percent).