73 Pages Posted: 6 May 2010
Date Written: April 29, 2010
This paper compares the role of stochastic volatility versus changes in monetary policy rules in accounting for the time-varying volatility of U.S. aggregate data. Of special interest to the authors is understanding the sources of the great moderation of business cycle fluctuations that the U.S. economy experienced between 1984 and 2007. To explore this issue, the authors build a medium-scale dynamic stochastic general equilibrium (DSGE) model with both stochastic volatility and parameter drifting in the Taylor rule and they estimate it non-linearly using U.S. data and Bayesian methods.
Methodologically, the authors show how to confront such a rich model with the data by exploiting the structure of the high-order approximation to the decision rules that characterize the equilibrium of the economy. Their main empirical findings are: 1) even after controlling for stochastic volatility (and there is a fair amount of it), there is overwhelming evidence of changes in monetary policy during the analyzed period; 2) however, these changes in monetary policy mattered little for the great moderation; 3) most of the great performance of the U.S. economy during the 1990s was a result of good shocks; and 4) the response of monetary policy to inflation under Burns, Miller, and Greenspan was similar, while it was much higher under Volcker.
Keywords: DSGE models, Stochastic volatility, Parameter drifting, Bayesian methods
JEL Classification: E10, E30, C11
Suggested Citation: Suggested Citation
Fernández-Villaverde, Jesús and Guerrón-Quintana, Pablo and Rubio-Ramirez, Juan Francisco, Fortune or Virtue: Time-Variant Volatilities Versus Parameter Drifting in U.S. Data (April 29, 2010). FRB of Philadelphia Working Paper No. 10-14. Available at SSRN: https://ssrn.com/abstract=1600862 or http://dx.doi.org/10.2139/ssrn.1600862