Great Moderation

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US annualized real GDP growth from 1950 to 2010, showing the years of the Great Moderation.

In economics, the Great Moderation refers to a reduction in the volatility of business cycle fluctuations starting in the mid-1980s, believed to have been caused by institutional and structural changes in developed nations in the later part of the twentieth century.[1] Sometime during the mid-1980s major economic variables such as real GDP growth, industrial production, monthly payroll employment and the unemployment rate began to decline in volatility.[2]

Contents

Origins of the term [edit]

Chang-Jin Kim and Charles Nelson (1999)[3] and Margaret McConnell and Gabriel Pérez-Quirós (2000)[4] calculated that U.S. output volatility had declined substantially in the early 1980s. This phenomenon was called a "great moderation" by James Stock and Mark Watson in their 2002 paper, "Has the Business Cycle Changed and Why?".[5] It was brought to the attention of the wider public by Ben Bernanke (then member and now chairman of the Board of Governors of the Federal Reserve) in a speech at the 2004 meetings of the Eastern Economic Association.[2][6]

Causes [edit]

The Great Moderation has been attributed to various causes:

  • Improved government economic stabilization policy (particularly monetary policy)[7]
  • Greater central bank independence, in which the Fed balanced money supply more closely with demand[8][9]
  • Reduced, or stabilized, government regulation and taxation[10]
  • Improved inventory control and supply chain management[7]
  • Economic good luck (partly from productivity and commodity price shocks)[11][12]

Researchers at the US Federal Reserve and at the European Central Bank have rejected the 'good luck' explanation and attribute it mainly to improved monetary policies.[2][7][13] According to John B. Taylor, originator of the Taylor rule, the Great Moderation resulted from the abandonment of discretionary macroeconomic policy by the federal government, and the adoption of a rules-based macroeconomic policy instead (working mainly through monetary policy).[14] Research has indicated that U.S. monetary policy contributed to the drop in the volatility of U.S. output fluctuations and to the decoupling of household investment from the business cycle that characterized the Great Moderation.[15]

Effects [edit]

It has been argued that the greater predictability in economic and financial performance associated with the Great Moderation caused firms to hold less capital and to be less concerned about liquidity positions.[citation needed] This, in turn, is thought to have been a factor in encouraging increased debt levels and a reduction in risk premia required by investors.[citation needed]. According to Hyman Minsky the great moderation enabled a classic period of financial instability, with stable growth encouraging greater financial risk taking.

On the economics profession [edit]

An example of the over confidence of the economic profession in this period (prior to 2008) given by Robert Lucas, in his 2003 presidential address to the American Economic Association, where he declared that the "central problem of depression-prevention [has] been solved, for all practical purposes".[16]

Possible end [edit]

Economists speculate that the late-2000s economic and financial crisis may have brought the period of the Great Moderation to an end.[17] Richard Clarida at PIMCO considers the period of the Great Moderation to be roughly between 1987–2007, and it is characterised by "predictable policy, low inflation, and modest business cycles." [18]

See also [edit]

References [edit]

  1. ^ Baker, Gerard (2007-01-19). "Welcome to 'the Great Moderation'". The Times (London: Times Newspapers). ISSN 0140-0460. Retrieved 15 April 2011. 
  2. ^ a b c Bernanke, Ben (February 20, 2004). "The Great Moderation". federalreserve.gov. Retrieved 15 April 2011. 
  3. ^ Kim, Chang-Jin; Charles Nelson (1999). "Has the U.S. economy become more stable? A Bayesian approach based on a Markov-switching model of the business cycle". Review of Economics and Statistics. 
  4. ^ McConnell, Margaret; Gabriel Pérez-Quirós (2000). "Output fluctuations in the United States: what has changed since the early 1980s?". American Economic Review. 
  5. ^ Stock, James; Mark Watson (2002). "Has the business cycle changed and why?". NBER Macroeconomics Annual. 
  6. ^ "Origins of ‘The Great Moderation'". The New York Times. 23 January 2008. 
  7. ^ a b c Summers, Peter M (2005). "What caused the Great Moderation? Some cross-country evidence". Economic Review Federal Reserve Bank of Kansas City 90. Retrieved 15 April 2011. 
  8. ^ What Have We Learned Since October 1979? Remarks by Fed governor Ben Bernanke (2004)
  9. ^ Capitalism 4.0: The Birth of a New Economy in the Aftermath of Crisis By Anatole Kaletsky
  10. ^ Inflation targets and central bank independence
  11. ^ Davis, Steven; James Kahn (May 2008). "Interpreting the Great Moderation: Changes in the Volatility of Economic Activity at the Macro and Micro Levels". NBER Working Paper. 
  12. ^ Benati, Luca (2008-01-30). "The "Great Moderation" in the United Kingdom". Journal of Money, Credit and Banking. doi:10.1111/j.1538-4616.2008.00106.x. 
  13. ^ Giannone, Domenico; M Lenza (February 2008). "Explaining the great moderation: It is not the shocks". European Central Bank Working Paper Series. doi:10.1162/JEEA.2008.6.2-3.621. 
  14. ^ Taylor, John (2011). "The Cycle of Rules and Discretion in Economic Policy". National Affairs (7). 
  15. ^ Federal Reserve Bank of Chicago, Monetary Policy, Output Composition and the Great Moderation, June 2007
  16. ^ Robert E. Lucas, Jr. (2003-01-10). Macroeconomic Priorities (pdf). p. 1. Retrieved 2011-04-18. 
    "Home page of Robert E. Lucas, Jr. at the University of Chicago". Retrieved 2011-04-18. 
  17. ^ Quiggin, John (2011 [last update]). "Refuted economic doctrines #3: The Great Moderation". Crooked Timber. Retrieved 15 April 2011. 
  18. ^ http://www.pimco.com/LeftNav/Global+Markets/Global+Perspectives/2010/Global+Perspectives+July+2010+New+Normal.htm
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