Examining the great moderation hypothesis for Canada

A number of studies have documented a reduction in the volatility of the growth rate of US GDP since the mid-1980s. This reduction has been called “the great moderation.” In this paper I investigate the possibility of a great moderation in Canada and find evidence of a moderation beginning in the third quarter of 1981(1981:3). A decomposition of the variances and covariances of the components of GDP indicates that a fall in the variance of the interest-rate sensitive components accounts for the . Using a structural VAR model, I find evidence of a reduction in the response of output and the inflation rate to monetary policy shocks after 1981:3. Counterfactual experiments demonstrate that monetary policy has not become less effective. The main finding is that more stable monetary policy accounts for the drop in volatility of output.