Essay About Volatility Of Quarterly Real Gdp Growth And Important Components Of Real Gdp

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Over the last decade and a half, the United States
has experienced an unprecedented period of stable
economic growth. Indeed, in the period since 1984, the
volatility of quarterly real GDP growth has been only
half that of the preceding twenty-five years. This
pronounced decline in aggregate volatility invites us
to take a closer look at the volatility trends within
important components of real GDP–specifically, consumer
spending, residential and business investment,
government purchases, and international trade. To what
extent has each of these sectors shared in the increased
stability of the overall economy?
In this edition of Current Issues, we address this
question by comparing the volatility of growth exhibited
by each component before and after 1984. We also
seek to identify those components that contributed the
most to the overall drop in growth variability.1
Our analysis reveals that the growth rates of all the
major components of GDP have followed a steadier
course, with the most marked reductions in volatility
occurring in residential investment and trade. When we
weigh each component by its share in overall economic
growth, however, inventory investment and consumer
spending emerge as the chief contributors to the increased
stability of the economy since 1984. Because inventory
investments share of GDP is very small, the important
role played by this component is particularly striking.
We also examine the composition of the more stable
economy across the stages of the business cycle. We
find that the growth of GDP and its components has
been smoother in both recessions and expansions. Thus,
the drop in volatility cannot be attributed solely to a
simple decline in the number and severity of recessions
in recent years.
Two Types of Explanations
Increased stability in the growth of aggregate GDP and
its individual components may reflect two broad types
of changes in the economic environment since the early
1980s. First, structural changes–such as technological
innovations and regulatory shifts–may have helped
smooth economic fluctuations in some sectors. Indeed,
in the early 1980s, many structural changes were under
way that may have improved certain sectors ability to
respond to changes in demand and to absorb economic
shocks. These improvements, in turn, could have led to
more stable growth.
The second type of explanation–while potentially
important–goes far beyond the scope of the simple
decomposition analysis presented here. This explanation
relates to the role of monetary policy and economic
shocks in the variability of economic growth. It is possible
that a stabilizing monetary policy and smaller economic
shocks–“good policy and good luck”–may have played
a role in the decline of overall volatility.2 While this
second explanation clearly deserves further research, we
focus our analysis solely on possible structural explanations
for the more stable growth.
The Decline in the Volatility of GDP Growth
A glance at the path of real GDP growth in recent
decades suggests that volatility dropped markedly not
long after the 1981-82 recession (Chart 1). Employing
advanced statistical techniques, McConnell and Perez
Quiros (1998) identify the date of the volatility drop
in GDP growth as the first quarter of 1984. In our
analysis, we use this date to split our sample into two
periods: 1959-83 and 1984-98. When we calculate the
volatility of GDP growth–measured by the standard
deviation of quarterly growth rates–for each of the two
periods, we find a significant 2.2 percentage point drop
from the first period to the second.3
Similar calculations for the growth rates of the major
components of GDP show that all have become less
volatile in the later period (Table 1). Residential investment,
exports, and imports experienced the largest
absolute declines in growth volatility, while federal
government purchases and consumer spending experienced
the smallest reductions in volatility. The fact that
growth patterns in each of the major components of
GDP reflected the decline in aggregate