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Gali and Gambetti On the Sources of the Great Moderation

Gali and Gambetti On the Sources of the Great Moderation. Good luck? ………. No major shocks Good practice? … JIT inventory management Production smoothing Financial innovations – risk sharing Good policy? ……. Inflation targeting – Taylor Rule:

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Gali and Gambetti On the Sources of the Great Moderation

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  1. Gali and GambettiOn the Sources of the Great Moderation Good luck? ………. No major shocks Good practice? … JIT inventory management Production smoothing Financial innovations – risk sharing Good policy? ……. Inflation targeting – Taylor Rule: - oppose demand-side shocks - accommodate supply shocks

  2. Output = Hours x Productivity • Figure 1A. Output volatility – decline in early 1980s • Hours volatility down most sharply  smoothing

  3. Output = Hours x Productivity • Figure 1A. Output volatility – decline in early 1980s • Hours volatility down most sharply  smoothing • Figure 1B.Output volatility down more than its components

  4. Output = Hours x Productivity • Figure 1A. Output volatility – decline in early 1980s • Hours volatility down most sharply  smoothing • Figure 1B.Output volatility down more than its components : An explanation :

  5. Output = Hours x Productivity • Figure 1A. Output volatility – decline in early 1980s • Hours volatility down most sharply  smoothing • Figure 1B.Output volatility down more than its components : An explanation : • Figure 2. Hours – Productivity correlation switched from positive to negative in 1980s • ρpre-1984= .18 • ρpost-1984= -.41 • Challenges RBC theory: when productivity up, hours ought to rise

  6. Decomposing Shocks Technology shocks (= “supply-side” shocks) persist Non-tech shocks (residuals = “demand-side”) revert

  7. Decomposing Shocks Technology shocks (= “supply-side” shocks) persist Non-tech shocks (residuals = “demand-side”) revert Volatility conditional on tech- and non-tech shocks • Output volatility conditioned on tech-shocks: modest decline • Output volatility conditioned on non-tech shocks: sharp decline

  8. Decomposing Shocks Technology shocks (= “supply-side” shocks) persist Non-tech shocks (residuals = “demand-side”) revert Volatility conditional on tech- and non-tech shocks • Hours volatility conditioned on non-tech shocks: sharp decline

  9. Decomposing Shocks Technology shocks (= “supply-side” shocks) persist Non-tech shocks (residuals = “demand-side”) revert Volatility conditional on tech- and non-tech shocks • Output volatility conditioned on tech-shocks: modest decline • Output volatility conditioned on non-tech shocks: sharp decline • Hours volatility conditioned on non-tech shocks: sharp decline supports policy view, unless non-tech shocks themselves small rejects RBC view that tech-shocks matter most

  10. Decomposing Shocks Technology shocks (= “supply-side” shocks) persist Non-tech shocks (residuals = “demand-side”) revert Volatility conditional on tech- and non-tech shocks • Fluctuations in productivity largely accounted for by tech-shocks, as would be expected

  11. Correlations conditional on tech- and non-tech shocks Focus on Hours – Productivity Correlation • Non-tech explains drop in Hours – Productivity correlation after 1990, i.e., after onset of Great Moderation • Consistent negative contribution of tech shocks increased relative importance of tech shocks decreased relative importance of non-tech shocks

  12. Correlations conditional on tech- and non-tech shocks Focus on Hours – Productivity Correlation • Decline in Hours – Productivity correlation in late period is conditional on non-tech shocks • Conclude: “Good policy” response to small non-tech shocks  Great Moderation

  13. Implications and Conclusions • “Good policy” response to small non-tech shocks  Great Moderation • High and positive Hours – Productivity correlation conditional on non-tech, demand-side shocks in early period explained by labor hoarding • Increased labor market flexibility in late period • Reduced labor hoarding  Great Moderation Sources of the Great Moderation Good policy Good practice Not luck But now an update …

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