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Studying the Great Moderation

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Studying the Great Moderation
Randi Pittman
MBA6008 – Section 101
Unit 6 – Assignment 1
02/15/2013

There are many things which could affect economic volatility. In fact, I recently read a case study which described this situation. The case study was entitled “The Great Moderation, Dead or Alive?” or “The Great Moderation,” for short. This case study was written by Diego Comin and was published by the Harvard Business School (Comin, 2011). The author begins by giving us a background on the situation that he analyzed. The case in question has often been referred to as the Great Moderation. After thoroughly describing this time period, Comin then provides us with some rationalizations for this occurrence (Comin, 2011). Next, the topics of the variance of stocks and reduced amplification were covered (Comin, 2011). There were also other possible causes of changes in volatility discussed; such as globalization, inventory management, policy, demographics, and technological diffusion (Comin, 2011). Well put together, the case study is an excellent example of how one can analyze an economic situation. To begin, let’s take a look at what happened during the time period known as the great moderation. During this time period, which began in the 80’s, there was a reduction in the volatility of output (Comin, 2011). Exactly what does this mean? In terms of economics, volatility can be defined as “a measure of risk based on the standard deviation of the asset return” (Volatility, 2013). In lamens terms, it is the measure of how far above or below the normal; the output will rise or fall. Much like in the general definition of volatile, economic volatility could describe a period of erratic unpredictable rises or falls in levels of output. During the Great Moderation, levels of volatility were reduced or were more stable. Comin tells readers that in 2004, the then Chairman of the Federal Reserve, Ben Bernanke, stated that “reduced macroeconomic volatility has numerous benefits. He also went on by adding that one of the most striking features of the economic landscape over the past twenty years or so has been a substantial decline in macroeconomic volatility and that reduced macroeconomic volatility has numerous benefits” (Comin, 2011). When we take a look at the chart in exhibit 2F, we see the measure of volatility of total factor productivity form 1954 – 2002 (Comin, 2011). According to this chart the volatility in 1980 hovered around 2.4% (Comin, 2011). It was around this year that volatility rates started to drop; by the year 1991, the rate had decreased to around 1% (Comin, 2011). The rate has only continued to decrease in the years since. In fact, in 2003, the volatility rate had dropped to approximately 0.8% (Comin, 2011). This may not seem like a large reduction in percentage points. However when you take into account the amount of output affected, it’s easier to see the enormity of the situation. Volatility rates for other economic components decreased as well, such as in the case of investments. In 1980, the volatility rate of investment was approximately 17%, by 2001 the rate had decreased and hovered around 6% (Comin, 2011). As mentioned before, lower volatility rates mean conditions in the market are less likely to go haywire, or they are less volatile, in lamens terms, less explosive. Now that we know about the background of the time period, let’s take a look at what may have caused it. Comin stated that “economic fluctuations are the result of shocks that hit the economy and in turn have ripple effects on GDP” (Comin, 2011). He gives us two avenues to follow in order to rationalize the phenomena, the shocks which hit the economy aren’t as severe or what actually causes shocks in the economy don’t affect the shocks themselves on such a great level (Comin, 2011). Comin breaks down possible causes for the drop in volatility rates next. The first possible cause involves there being a lower variance in shocks (Comin, 2011). The example given here, deals with the shocks being exogenous (Comin, 2011). This means that the shocks in the economy are not caused by economic factors, for example, causes such as war or oil crises. “Thus, part of the higher instability we observed during this period is due to bad luck” (Comin, 2011). However, it would be hard to prove this theory. The next cause involves reduced amplification. “Not all sectors are equally volatile” (Comin, 2011). “However, the changing weights of services and goods producing sectors did not contribute much to the Great Moderation” (Comin, 2011). “Globalization explanations do not account for the declining volatility of productivity growth” (Comin, 2011). In terms of inventory management, it really doesn’t explain the changes in rates either. The author offers policy changes as a possible cause as well. The government utilizes policy making as a way to stabilize the economy. They change interest rates, the supply of money, and inflation rates. Could this component of the economy have caused the Great Moderation? The author doesn’t believe so. Next, he gives us demographics as a possible cause. “When a shock hits the Economy and lowers real wages, younger workers tend to curtail their labor supply more than older workers. Therefore as the share of younger workers in the population diminishes, the response of aggregate labor supply to shocks also diminishes” (Comin, 2011). He believes that this explanation has the potential to account for the international component of the trend. The adoption of technology has really sped up since the early 80’s. Technology changes everything. This is true for countries all over the world. The author believes that because of the fact that it is occurring all over the world, it could account for the international component as well (Comin, 2011). The Great Moderation ended around the time that the Great Recession started in the late 2000’s. Now that it has ended, many wonder what the economy will do. Comin believes that it is still up in the air whether volatility rates will revert back to the levels they were at during the Great Moderation. In conclusion, the author presented us with a complex, well put together case study. During the Great Moderation, volatility rates decreased. This could have been caused by many things. Comin suggests many different causes and then analyzes each one for readers. Examples were given so that we can see how each economic component analyzed could affect volatility rates. All together, the case study was well planned out and serves as an excellent example of how a portion of the economy can affect other portions.

Works Cited
Comin, D. (2011). The great moderation, dead or alive? The Harvard Business School, 13-28. Retrieved February 15, 2013.

Volatility. (n.d.). The Free Dictionary. Retrieved February 15, 2013, from http://financial-dictionary.thefreedictionary.com/Volatility+(economics)

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