1 What's so Great about the Great Moderation? A Multi-Country Investigation of Time- Varying Volatilities of Output Growth and Inflation ♦ John W. Keating ♠ Victor J. Valcarcel ♣ January 22, 2012 Abstract: Changes in volatility of output growth and inflation are examined for eight countries with at least 140 years of uninterrupted data. Time-varying parameter vector autoregressions are used to estimate standard deviations of each variable. Both volatilities rise quickly with World War I and its aftermath, stay relatively high until the end of World War II, and then drop rapidly until the mid- to late 1960s. This Postwar Moderation typically yields the largest decline in output growth volatilities. For all countries, volatilities of both output growth and inflation fall more during this Postwar Moderation than during the Great Moderation, and often the difference is huge. Both volatilities typically reach their lowest levels following the Great Moderation. The Great Moderation often counteracts an increase in volatility that took place in the 1970s, particularly for inflation. In nearly all the countries in our sample, the recent financial crisis has eliminated the stability gains associated with the Great Moderation, and sometimes it has even eroded gains made during the Postwar Moderation. Periods in which a fixed exchange rate system was widespread are associated with relatively low volatilities for both variables. Based on our structural VAR identification, permanent shocks to output account for nearly all of the fluctuations in the volatility of output growth while shocks that have only a temporary effect on output explain most of the fluctuations in inflation volatility. These last two findings suggest that changes in the volatility for each variable are primarily driven by a fundamentally different type of disturbance. JEL Classification: E30, E31, E65 Keywords: The Great Moderation; The Postwar Moderation; stochastic volatility; permanent- transitory shock decompositions; Markov Chain Monte Carlo; structural vector autoregressions. ♦ We thank Tim Cogley and Luca Gambetti for helpful correspondence and sharing Matlab code. Results from a previous version of the paper titled "Time Varying Volatilities of Output Growth and Inflation: A Multi-country Investigation" were presented at the 22 nd (EC) 2 Conference: “Econometrics for Policy Analysis: After the Crisis and Beyond” in Florence, the 2011 Western Economic Association Meetings in San Diego, and the 2011 Midwest Econometric Group Meetings in Chicago. We thank participants in those sessions for constructive comments, particularly Mark Watson, Frank Smets and Pooyan Ahmadi. The customary disclaimers apply. ♠ Department of Economics, The University of Kansas, 334 Snow Hall, Lawrence, KS 66045 E-mail: jkeating@ku.edu ♣ Department of Economics, Texas Tech University, 257 Holden Hall, Lubbock, TX 79409 E-mail: vic.valcarcel@ttu.edu