A Monthly Volatility Index for the US Economy

We estimate the monthly volatility of the US economy from 1968 to 2006 by extending the coincidentindex model of Stock and Watson (1991). Our volatility index, which we call VOLINX, hasfour applications. First, it sheds light on the Great Moderation. VOLINX captures the decrease in thevolatility in the mid-80s as well as the different episodes of stress over the sample period. In the 70sand early 80s the stagflation and the two oil crises marked the pace of the volatility whereas 09/11 is themost relevant shock after the moderation. Second, it helps to understand the economic indicators thatcause volatility. While the main determinant of the coincident index is industrial production, VOLINXis mainly affected by employment and income. Third, it adapts the confidence bands of the forecasts.In and out-of-sample evaluations show that the confidence bands may differ up to 50% with respect to amodel with constant variance. Last, the methodology we use permits us to estimate monthly GDP, whichhas conditional volatility that is partly explained by VOLINX. These applications can be used by policymakers for monitoring and surveillance of the stress of the economy.