Great moderation
The main purpose of this paper is to give a detailed explanation of the nature of volatility and correlation of cyclical consumption, investments, and gross domestic product (GDP) components. The key area of focus will be on great moderation, where an insight explanation will be expounded on the period the United States economy experienced a great volatility break on its economic variables. The great moderation in the US economy can be defined as the period when there was a remarkable decline in the macroeconomic variables before 1984. The volatility variation experienced by the US economy were mainly accompanied by a large change in the trend of productivity and output. The trend changes are reflected in the correlation and volatility of the consumption, investments, and GDP. To fully understand the great moderation in the US economy before 1984 a simple macroeconomic model will be deployed to explain the possible reasons for the observed changes.
Economic technology is viewed as a key indicator in the increase of GDP, which highly contributes to the investments thus boosting output. The contribution of technology shocks on the GDP volatility appeared to have increased over time, both in absolute and relative terms. One of the key indicators is that before 1984 there was a drastic decline in GDP as well as investments. This resulted in a great depression in the economic trend which has remained low in the mid-1980s. As indicated in the standard deviation of the cyclical components table, the decline in consumption, investments, and GDP has not been proportional. The volatility of consumption has dropped considerably relative to the volatility of GDP. However, investments volatility has significantly dropped over the same period of the mid-1980s. secondly, considering the correlation between the three macroeconomic variables, there is a considerable change. The correlation between the three macroeconomic variables displays a remarkable trend before 1984. Specifically, the correlation between the three variables has shown a remarkable decline with figures shifting from close to 2% to below 1% before 1984. The correlation decline in the investments before 1984 has experienced a substantial drop from 7% to 4%. The economic implication of this correlation drop explains the substantial proportion of economic output volatility. Precisely, the decline in correlation has been one of the contributing factors to the great moderation.
As pointed out earlier, the great moderation can be largely explained by the economic variables, one being both technology and non-technology shocks which causes a variance in the GDP, consumption, and investments. Such variance in economic variables can be further explained by the conditional volatility of productivity and output. Inclusion of technological shocks is one of the major factors that have seen the vitality and correlation increase after 1984. The increase in consumption, GDP, and investments have been associated by a larger effect in the US economic output levels. Using macroeconomic model, the observed significant change during the great moderation can be explained by two key developments;
A change in the interest rate thus causing a larger change in the stabilization of the inflation for investments.
An apparent termination of the short run in the productivity thus effecting both the consumption and GDP.
The changes in volatility during the great moderation can also be summarized by the labour market. The labour productivity highly contributes to the GDP and investment as well. A standard deviation has been shown before and after 1984 with a correlation ration represented in both GDP and investments. During the great depression before 1984, there was an intensive decline in productivity as a result of a decline in labour market supply thus affecting GDP. After 1984, there has been a substantial increase in the labour market hours thus causing an increase in the GDP and investments. This economic implication of the labour market trends is explained in the volatility and correlation between the three economic variables.
After an economic downtown I the mid-1980’s, the US economy experienced a great recession in 2008 with an increasing trend in GDP, consumption, and investment. During this period, the volatility and correlation statistics started to increase. The GDP and consumption volatility increased remarkably, shifting the values from below 1% to above 1%. The investment percentage showed a massive increase during the US great recession in 2008. It is during this period of great recession where the declining trend was broken and the US economy started to stabilize and reported favourable statistics. The economy increased the inclusion of both technological and non-technological factors which has increased the volatility overtime after 1984. The increase in correlation between the three economic variables was as a result of consequent larger effects on interest rates, labour market, and productivity. A standardized macroeconomic model showed a significant fraction in the overall observed changes in trends. Specifically, the standard deviation of cyclical components from the great depression to great recession reported a positive trend with stable economic indicators in 2008.
The great moderation experienced in the US economy since the mid-1980s has not persistent because the trend was broken in the great recession in 2008. The stabilization of the economy in the great recession broke the declining trend in the correlation and volatility in 2008. As a result, the broken trend improved the consumption, GDP, and investment of the US economy.
In conclusion, the paper tried to analyze the nature of volatility and correlation of cyclical consumption, investments, and gross domestic product (GDP) components to the great moderation. Through the macroeconomic analytics, great moderation was experienced in the mid-1980s with a significant decline in volatility and correction between the economic variables. Post-1984, the US economy experienced an increasing trend in consumption, GDP, and investment. In 2008, the economy broke the trend which was experienced during the great moderation in the mid-1980s. In 2008, the great recession was experienced reporting a positive and increasing correlation between the three economic variables, signifying stabilization of the US economy. The US economy came back to recess as a result of deploying both technological and non-technological factors which have increased the volatility after 1984 through 2008. At this point, the great moderation did not persist in the US economy thus the economy stabilized.