Great Moderations and U.S. Interest Rates: Unconditional Evidence

James M. Nason and Gregor W. Smith
Working Paper 2008-1a
Revised May 2008

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The Great Moderation refers to the fall in U.S. output growth volatility in the mid-1980s. At the same time, the United States experienced a moderation in inflation and lower average inflation. Using annual data since 1890, we find that an earlier 1946 moderation in output and consumption growth was comparable to that of 1984. To assess the impact of these moderations, we also isolate the 1969–83 Great Inflation using quarterly data since 1947. We then examine the quantitative predictions of a consumption-based asset pricing model for shifts in the unconditional average of U.S. interest rates across these time periods. A central finding is that such shifts probably were related to changes in average inflation rather than to moderations in inflation and consumption growth.

JEL classification: E32, E43, N12

Key words: Great Moderation, asset pricing, interest rate

The authors thank the Social Sciences Research Council of Canada and the Bank of Canada research fellowship program for support of this research, Budina Naydenova for help with New York Stock Exchange stock return data, and Annie Tilden for assistance with the pre-1947 data sources. Smith thanks the Research Department of the Federal Reserve Bank of Atlanta and the Department of Economics at the University of British Columbia for providing the environment for this research. They thank Pedro Silos, Ellis Tallman, and seminar participants at the Federal Reserve Bank of Atlanta, Simon Fraser University, Indiana University, the University of Victoria, Ryerson University, and the Bank of Japan for helpful comments. The views expressed here are the authors' and not necessarily those of the Bank of Canada, the Federal Reserve Bank of Atlanta, or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to James M. Nason, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, GA 30309-4470, 404-498-8891,, or Gregor W. Smith, Department of Economics, Queen's University, Kingston, Ontario, Canada K7L 3N6, 613-533-6659,

For further information, contact the Public Affairs Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, Georgia 30309-4470, 404-498-8020.