Economic fluctuations in most of the industrialised world have for over the past 30 years been characterised
by declining volatility. This decline has also been a trait witnessed for output fluctuations in the
Euro Area. This paper has two objectives. The first is to provide a comprehensive characterisation of
the decline in volatility using a large number of Euro area economic time series and a variety of methods
designed to describe the time-varying time series processes. The second objective is to provide new
evidence on the quantitative importance of various explanations for this ‘great moderation’. This paper
focuses on the central elements in the literature contending why real output growth has stabilised. Such
factors include shifts in the structure of the economy, improved policies, and a ‘good luck’ factor. Further,
this paper goes on to investigate whether cross-country linkages in growth have shifted, perhaps in
a way that can help rationalise the stabilisation in output. Taken together, the moderation in volatility
is attributable to a combination of improved policy (around 5 - 30 percent) and identifiable forms of
good luck that manifest themselves as smaller reduced-form forecast errors (40 percent).
This is a working paper. It is also available at: http://ideas.repec.org/p/lbo/lbowps/2006_21.html.