Perhaps the most remarkable trend in global macroeconomics over the past two decades has been the stunning drop in the volatility of economic growth. In the United States, for example, quarterly output volatility has fallen by more than half since the mid-1980’s. Obviously, moderation in output movements did not occur everywhere simultaneously. Volatility in Asia began to fall only after the financial crisis of the late 1990’s. In Japan and Latin America, volatility dropped in a meaningful way only in the current decade. But by now, the decline has become nearly universal, with huge implications for global asset markets.
Indeed, the main question for 2007 is whether macroeconomic volatility will continue to decline, fueling another spectacular year for markets and housing, or start to rise again, perhaps due to growing geopolitical tensions. I lean slightly toward the optimistic scenario, but investors and policymakers alike need to understand the ramifications of a return to more normal volatility levels.