The Long and Large Decline in U.S. Output Volatility
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Comment and Discussion

Benjamin M. Friedman: The goal of Olivier Blanchard and John Simon's paper is to study the business cycle, focusing in particular on aggregate real output in the United States. Their principal finding is that the shocks affecting output growth have become less volatile in recent years. The standard error of the autoregression that serves as their central vehicle of analysis, estimated on a rolling-sample basis, has declined from about 1 percent a quarter (4 percent annualized), on average from the 1950s through the mid-1980s, to roughly ½ percent a quarter since then. Because the average growth rate of real output for the entire sample, from 1947 through 2000, is 0.9 percent a quarter, this sharp decline in the absolute magnitude of the estimated shocks obviously means that lately there have been fewer quarters when the measured growth rate has been less than zero. To the extent that movements of real GDP as measured by the U.S. Department of Commerce capture the broadly based fluctuations in nonfinancial economic activity that the NBER business cycle dating process emphasizes, there have therefore been fewer recessions.

The immediate question is what to make of this finding. In their introduction the authors say that their paper will "take up the question of whether recessions are special . . . . whether what we have seen over the last twenty years is simply the absence of large shocks and nothing more." They preview their conclusion as follows: ". . . this is not the case. The measured decrease in output volatility has little to do with the absence of large shocks in the recent past." Later on they summarize their results by stating, "The measured decline in output volatility is not due to the absence of large shocks over the past twenty years. What it captures [End Page 165] instead is the decline in the volatility of 'routine' quarter-to-quarter changes in GDP growth."

To be sure, one should not read the results of Blanchard and Simon's paper to say that the infrequency of recessions in the United States over the last two decades has reflected the absence of large shocks and nothing more. But the absence of large shocks certainly is a major part of what the authors have to report. Inspection of the estimated residuals from the authors' equation (which Olivier Blanchard was kind enough to provide to me) shows that, without exception, every one of the nine official NBER recessions in the United States since World War II has involved at least one negative residual larger (in absolute value) than the 0.9 percent mean quarterly growth rate of real output. And in the past there were plenty of large residuals other than just during recession episodes. Including both positives and negatives, from 1947 through 1984 their results show fifty-eight estimated residuals larger than 0.9 percent.

By contrast, since 1985 only four of their estimated quarterly residuals have exceeded 0.9 percent; two of these were positive and two negative. And one of the two large negatives occurred during the lone recession the United States has experienced during these years, that of 1990-91. (The other was in the first quarter of 1993.) Blanchard and Simon's basic point is that output has become less volatile, and this is surely true. But there is no way to duck the fact that, in their estimated autoregression, the absence of recessions is very much associated with the absence of large negative shocks.

Yet another way of looking at the data, which the authors do not discuss, leads to the same conclusion. It is conventional to estimate regressions for real output using quarterly data, presumably because the Commerce Department reports GDP this way. But no economic theory of which I am aware guarantees that the calendar quarter is the right level of time aggregation for investigating the kinds of shocks that matter for business cycles. A single large shock spread out over more than a single measured quarter would look in quarterly observations like a series of smaller shocks occurring over a sequence of consecutive quarters.

Blanchard and Simon's autoregression exhibits no meaningful serial correlation. (The Durbin-Watson...