THE ROLE OF SECTORAL SHIFTS IN THE DECLINE OF REAL GDP VOLATILITY

Abstract

U.S. production has shifted from goods-producing to service-producing industries. We assess whether this shift contributed to the decline in U.S. output volatility over the period 1949–2005 and provide an estimate of its relative importance. Growth rates of GDP by industry are analyzed in a seemingly unrelated multivariate autoregression framework with time-varying innovation covariance matrices. These changing unobserved covariance matrices are modeled as a Wishart autoregressive process of order one, which results in a nonlinear state-space system. The particle filter is used to obtain estimates of the innovation covariance matrix at each point in time. Several counterfactual experiments make it possible to apportion the decline in output volatility between the shift in the sectoral composition and changes in innovations. Our main finding is that the shift into the service sector can explain about 30% of the decline in GDP's volatility, despite the fact that some sectors became even more volatile. This result is robust across a wide variety of alternative specifications.