Great Moderation(s) and U.S. Interest Rates: Unconditional Evidence
James M. Nason
Gregor W. Smith
The US economy experienced a Great Moderation sometime in the mid-1980s -- a fall in the volatility of output growth -- at the same time as a fall in both the volatility of inflation and the average rate of inflation. We put this moderation in historical perspective by comparing it to the post-WWII moderation. According to theory, the statistical moments -- both real and nominal -- that shift during these moderations in turn influence interest rates. We examine the predictions for shifts in the unconditional average of US interest rates. A central finding is that such shifts probably were due to changes in average inflation rather than to those in the variances of inflation and consumption growth.
great moderation, asset pricing
The Great Moderation refers to the fall in U.S. output growth volatility in the mid-1980s. At the same time, the United States experienced a moderation in inflation and lower average inflation. Using annual data since 1890, we find that an earlier, 1946 moderation in output and consumption growth was comparable to that of 1984. Using quarterly data since 1947, we also isolate the 1969–83 Great Inflation to refine the asset pricing implications of the moderations. Asset pricing theory predicts that moderations—real or nominal—influence interest rates. We examine the quantitative predictions of a consumption-based asset pricing model for shifts in the unconditional average of U.S. interest rates. A central finding is that such shifts probably were related to changes in average inflation rather than to moderations in inflation and consumption growth.
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