Analyzing U.S. Output and the Great Moderation by Simultaneous Unobserved Components


  • This research was supported by the Deutsche Forschungsgemeinschaft through the CRC 649 “Economic Risk.” The paper took substantial benefit from the suggestions of two anonymous referees. I am grateful to Jürgen Wolters, Cordelia Thielitz as well as participants of the ZEW “Recent Developments in Macroeconomics” 2009 conference, the 25th Annual Congress of the EEA, the Departmental Seminar at the University of Heidelberg, and the Research Seminar at RWTH Aachen University for their comments. Of course, all remaining errors are my own.


This paper seeks to determine the causal interaction between structural trend and cycle innovations in an unobserved components framework of aggregate output. For the purpose of identification, I propose allowing for shifts in volatility. This strategy provides good estimation precision when applied to U.S. industrial production. In the early 1980s, predominance of cycle shocks gives way to strong negative spillovers of trend impulses, consistent with real business cycle theories. The coincident reduction of macroeconomic volatility was mainly caused by pronounced dampening of transitory disturbances. This is in accordance with an important role of macroeconomic policy in explaining the Great Moderation.