Comment on: “Can financial innovation help to explain the reduced volatility of economic activity?”

As Dynan, Elmendorf, and Sichel (henceforth DES) note, the volatility of economic activity fell substantially sometime from the middle of the 1980s to the early 1990s. This decline is documented by McConnell and Perez-Quiros (2000) and Kim and Nelson (1999). Indeed, as shown in Table 1 of DES, the standard deviation of quarterly GDP growth was 4.4% in the 1960-1984 period, but 2.1% in the 1985-2004 period. Among the explanations given for the decline in macroeconomic volatility are a shift in the economy from production to services, changes in monetary policy, and changes in inventory management. It is also possible that the lower volatility is largely a consequence of luck: the economy has been favored by smaller shocks, as emphasized by Stock and Watson (2002). DES propose a different explanation: that financial innovation has led to this decline.