Cross-Country Interactions, the Great Moderation and the Role of Output Volatility in Growth

This paper investigates the effect of output volatility and the great moderation on growth in a model that simultaneously accounts for cross-country interactions, structural breaks and heterogeneous effects. This is done by augmenting the univariate GARCH-M model of growth for each G7 country with cross-country weighted averages of growth and shift dummies. I find that volatility affects growth positively, that there is a great moderation in five of the G7 countries and that the great moderation has a negative effect on growth in all G7 countries. A simulation exercise shows that cross-country interactions are important in estimating the volatility effect.