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Federal Reserve Bank of Atlanta
FRB Atlanta Working Paper
Sources of the Great Moderation: shocks, frictions, or monetary policy?
Zheng Liu
Daniel F. Waggoner
Tao Zha

We study the sources of the Great Moderation by estimating a variety of medium-scale dynamic stochastic general equilibrium (DSGE) models that incorporate regime switches in shock variances and the inflation target. The best-fit model—the one with two regimes in shock variances—gives quantitatively different dynamics compared with the benchmark constant-parameter model. Our estimates show that three kinds of shocks accounted for most of the Great Moderation and business-cycle fluctuations: capital depreciation shocks, neutral technology shocks, and wage markup shocks. In contrast to the existing literature, we find that changes in the inflation target or shocks in the investment-specific technology played little role in macroeconomic volatility. Moreover, our estimates indicate considerably fewer nominal rigidities than the literature suggests.

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Zheng Liu & Daniel F. Waggoner & Tao Zha, Sources of the Great Moderation: shocks, frictions, or monetary policy?, Federal Reserve Bank of Atlanta, FRB Atlanta Working Paper 2009-03, 2009.
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Keywords: Econometric models
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