“Great moderation” and risk premia volatility

The “great moderation” refers to a situation of low volatility in real growth, inflation and risk-free interest rates. The euro zone has experienced a great moderation from 1987 to 1994, 1998 to 2007 and since 2012. At the same time, however, the volatility of risk premia has increased sharply, in stark contrast with the great moderation for the other variables. What accounts for this high volatility in risk premia? The likely explanation is that the volatility of inflation is low, central banks do not want to “lea n against the wind” (conduct more restrictive monetary policies to prevent overborrowing and excessive growth in asset prices) and macroprudential policies are weak. Naturally, this results in low volatility in risk-free interest rates and high volatility in risky asset prices .