VAR Analysis and the Great Moderation

40 Pages Posted: 26 Feb 2008

See all articles by Luca Benati

Luca Benati

European Central Bank (ECB)

Paolo Surico

London Business School - Department of Economics; Centre for Economic Policy Research (CEPR)

Date Written: February 2008


Most analyses of the U.S. Great Moderation have been based on structural VAR methods, and have consistently pointed towards good luck as the main explanation for the greater macroeconomic stability of recent years. Based on an estimated New-Keynesian model in which the only source of change is the move from passive to active monetary policy, we show that VARs may misinterpret good policy for good luck. First, the policy shift is sufficient to generate decreases in the theoretical innovation variances for all series, and decreases in the variances of inflation and the output gap, without any need of sunspot shocks. With sunspots, the estimated model exhibits decreases in both variances and innovation variances for all series. Second, policy counterfactuals based on the theoretical structural VAR representations of the model under the two regimes fail to capture the truth, whereas impulse-response functions to a monetary policy shock exhibit little change across regimes. Since these results are in line with those found in the structural VARbased literature on the Great Moderation, our analysis suggests that existing VAR evidence is compatible with the 'good policy' explanation of the Great Moderation.

Keywords: Great Moderation, DSGE models, indeterminacy, vector autoregressions

JEL Classification: E38, E52

Suggested Citation

Benati, Luca and Surico, Paolo, VAR Analysis and the Great Moderation (February 2008). ECB Working Paper No. 866. Available at SSRN:

Luca Benati (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314

Paolo Surico

London Business School - Department of Economics ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom


Centre for Economic Policy Research (CEPR) ( email )

United Kingdom


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