Interest sensitivity and volatility reductions: Cross-section evidence

As has been widely observed, the volatility of GDP has declined since the mid-1980s compared to the prior years. One leading explanation of this decline is that monetary policy significantly improved in the later period. We utilize a cross-section of 2-digit manufacturing and trade industries to further investigate this explanation. Since a major channel through which monetary policy operates is through variation in the federal funds rate, we hypothesized that more interest sensitive industries should have experienced larger declines in the variance of their outputs in the post-1983 period. We estimate interest sensitivity measures for each industry from a variety of VAR models and then run cross-sectional regressions explaining industry volatility ratios as a function of their interest sensitivity measures. These regressions reveal little evidence of a statistically significant relationship between industry volatility reductions and our measures of the industry interest sensitivity. This result poses challenges for the hypothesis that improved monetary policy explains the decline in GDP volatility.