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This paper shows how U.S. monetary policy contributed to the drop in the volatility of U.S. output fluctuations and to the decoupling of household investment from the business cycle.

Monetary Policy, Output Composition and the Great Moderation
Last Updated: 07/17/07
This paper shows how U.S. monetary policy contributed to the drop in the volatility of U.S. output fluctuations and to the decoupling of household investment from the business cycle. The author estimates a model of household investment, an aggregate of nondurable consumption and corporate sector investment, inflation and a short-term interest rate. Subsets of the models' parameters can vary along independent Markov Switching processes. A specific form of switches in the monetary policy regimes, i.e. changes in the size of monetary policy shocks, affect both the correlation between output components and their volatility. A regime of high volatility in monetary policy shocks that spanned from 1970 to 1975 and from 1979 to 1984 is characterized by large monetary policy shocks contributions to GDP components and by a high correlation of household investment to the business cycle. This contrasts with the 1960s, the 1976 to 1979 period and the post 1984 era where monetary policy shocks have little impact on the fluctuations of real output.