Friday, February 15, 2008

The Great Moderation

Mark Thoma points us to a conference on the "Great Moderation".

Comin and Mulani also examine the effects of technological change on economic growth and volatility and, similarly, find that technological change leads to both faster growth and lower volatility. But in contrast to the previous paper, Comin and Mulani argue that this good result holds only for the national, or macro, measures. Indeed, predictions from their model suggest that firm-level, or micro, volatility should increase as the pace of technological innovation increases. To get this result, they consider an economy with two types of technologies: general innovations (GIs), which are not patentable and are used by all firms in the economy, and research and development innovations (RDI), which are patentable and used by a limited number of firms. They then assume that GIs are produced by large, stable firms and RDIs are produced by smaller, more volatile firms. Under these conditions, they show that increases in RDIs (for example, due to government research and development (R&D) subsidies) lead to market "shake-up," whereby smaller firms gain market share and perhaps even leapfrog ahead of the previous market leaders. Since GI activity relies on the presence of stable market leaders, this shake-up creates both firm-level volatility and lower GI activity. The decline in GIs, which by definition help all firms, reduces the comovement between firms in the economy, ultimately reducing the volatility of aggregate outcomes. Said more simply, if the increase in the innovative activity comes from small firms jockeying for position in the industry, aggregate volatility will go down, as winners and losers will offset each other, but microvolatility will rise, as losing firms compete to get back on top. Comin and Mulani provide empirical evidence showing that increased R&D activity in the U.S. has coincided with increased volatility in sales and market shares for publicly traded firms, reduced comovement across industries, and reduced volatility in aggregate economic growth.

Coincides with UK experience, an increase of internal volatility has been aligned with a fall in the overall shocks. However, the internal shocks are painful and they are the thing that make people say that risk has been shifted to the household from the firm. That's okay if you own the firm, but it is unlikely that those that have taken on this risk have been compensated

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