By means of stochastic volatility in the mean model to allow for time-varying parameters in the conditional mean and quarterly
data for the G7 countries, this article examines the dynamic nexus between the volatility of output and economic growth for
the G7 countries. This approach allows us to model parameter time-variation so as to reflect changes in the effect of volatility
appearing in both the conditional mean and the conditional variance. The evidence in this article indicates that the effect
of output volatility on output growth is strongly time-varying and quite analogous for all the G7 countries, with a break
around 1973. The effect of output volatility on growth becomes more negative after 1973, with negative and statistically significant
estimates after 1973 or the early 1990s. Our estimates show a reversal of the declining trend and a significant increase in
output volatility in the late 2000s, indicating that the Subprime Crisis brought a temporary break in the Great Moderation.
However, the Great Moderation seems to be generally restored by the mid-2010s. The effect of output growth on output volatility
is insignificant for all countries except for Italy and the USA, for which the estimates are positive and statistically significant.
Our estimates also show that output volatility is counter-cyclical for all countries.
Research group:Macroeconomics and European Economic Policy