Explanations for the Great Moderation in GDP volatility have included improved management of inventory schedules, the good luck of smaller economic shocks, and better anti-inflation policy. This article provides direct evidence on the changes in production behavior underlying these explanations within a market model for consumer durable goods. Long-run price and sales elasticities are estimated using VECMs for 1959 through 1983 (period I) and 1984 through 2008 (period II). Significant and more effective adjustments to output growth in response to both market disequilibria and changes in demand occur in period II and contribute to the reduced volatility observed. During that time, 95 percent of market disequilibrium gaps were closed after four quarters, and current output adjusted to accommodate 90 percent of demand changes occurring during the preceding three quarters.
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A trend term is included if any of the time series has a persistent trend for its entire time series (Franses 2001). An exclusion test is used below to determine if T is required. All variables are entered in natural log form except I t as in Giannone et al. (2008). Thus, only the estimates of β 2 and β 3 can be interpreted as the long-run market elasticities associated with logarithmic specifications of cointegration equations.
It is not possible to separate international transactions from the real output and sales time series since exports can be supplied from accumulated inventories or current production, while motor vehicle imports are a separate category that includes both consumer and non-consumer purchases.
Given that fluctuations in durable goods production are one of the leading contributors to the business cycle, the results below are likely to be relevant for the aggregate economy. For example, the simple correlation between the quarterly growth rates in consumer durable goods output and real GDP for the 1959–2008 period is 0.672 which is significant at the 0.01 level.
An examination of the time series for recursive residuals revealed large negative changes in 1974:IV and 1975:I and again in 1980:II. The period of steady and low residuals began in 1983:IV.
Demonstration of the Great Moderation effect does not imply or require a break in the long-run cointegration structure. Rather, the focus in this literature is on identifying significant changes in short-run behavior that help to explain the decline in output volatility that occurred.
A similar result holds for the entire 1959–2008 sample. The null hypothesis of non-exclusion could not be rejected for any variables in the preliminary estimation or the cointegration models shown in Table 2. The exclusion test developed by Johansen and Juselius (1990) is based on a likelihood ratio test.
The movement away from equilibrium occurs because higher levels of output are associated with higher, not lower, relative prices in the long-run estimation. However, as noted by Howitt (1990), given the dynamic interdependencies inherent in models with multiple endogenous variables, it is not unexpected that some variables will not move monotonically towards their long-run equilibrium value. In the present case, the signs of both the short-run adjustment and long-run elasticity parameters are consistent with market theory.
The period II coefficients on lagged values of ΔS t were jointly significant at the 0.05 level, while as a group they were insignificant in period I despite the significance of the parameter on the first lag of the sales variable. Estimates of the short-run VAR parameters for the ΔS t , ΔRP t , and ΔI t models were generally not significant, with one notable exception. During period II, sales growth was negatively related to changes in the real interest rate from two quarters ago. This implies that increases in real rates led to lower sales which would eventually have a negative impact on output growth.
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Blackley, P.R. Production Adjustments for Consumer Durables and the Great Moderation. Atl Econ J 39, 291–302 (2011). https://doi.org/10.1007/s11293-011-9283-1
- Output fluctuations
- Consumer durables
- Great Moderation
- E23 production
- E32 business fluctuations