The Great Moderation
Encyclopedia
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. Sometime during the mid-1980s major economic variables such as GDP, industrial production, monthly payroll employment and the unemployment rate began to decline in volatility.
and Mark Watson
in their 2002 paper, "Has the Business Cycle Changed and Why?". 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.
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. 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).
, 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".
may have brought the period of the Great Moderation to an end. 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."
Business cycle
The term business cycle refers to economy-wide fluctuations in production or economic activity over several months or years...
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. Sometime during the mid-1980s major economic variables such as GDP, industrial production, monthly payroll employment and the unemployment rate began to decline in volatility.
Origins
Chang-Jin Kim and Charles Nelson (1999) and Margaret McConnell and Gabriel Pérez-Quirós (2000) calculated that U.S. output volatility had declined substantially in the early 1980s. This phenomenon was called a "great moderation" by James StockJames H. Stock
James Harold Stock is an American economist and a professor of economics at Harvard University.- Academic career :Stock graduated with a B.S. in physics in 1978 from Yale University. He then went to the University of California-Berkeley and completed his M.A. in 1982 and Ph.D...
and Mark Watson
Mark Watson (economist)
Mark W. Watson is a professor of econometrics and currently teaches at Princeton University. Prior to coming to Princeton in 1995, Watson served on the economics faculty at Harvard and Northwestern....
in their 2002 paper, "Has the Business Cycle Changed and Why?". It was brought to the attention of the wider public by Ben Bernanke
Ben Bernanke
Ben Shalom Bernanke is an American economist, and the current Chairman of the Federal Reserve, the central bank of the United States. During his tenure as Chairman, Bernanke has overseen the response of the Federal Reserve to late-2000s financial crisis....
(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.
Causes
The Great Moderation has been attributed to various causes:- Improved government economic stabilization policy (particularly monetary policy)
- Greater central bank independence, in which the Fed balanced money supply more closely with demand
- Reduced, or stabilized, government regulation and taxation
- Improved inventory control and supply chain management
- Economic good luck (partly from productivity and commodity price shocks)
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. According to John B. Taylor
John B. Taylor
John Brian Taylor is the Mary and Robert Raymond Professor of Economics at Stanford University, and the George P. Shultz Senior Fellow in Economics at Stanford University's Hoover Institution....
, originator of the Taylor rule
Taylor rule
In economics, a Taylor rule is a monetary-policy rule that stipulates how much the central bank should change the nominal interest rate in response to changes in inflation, output, or other economic conditions. In particular, the rule stipulates that for each one-percent increase in inflation, the...
, 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).
Effects
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. This, in turn, is thought to have been a factor in encouraging increased debt levels and a reduction in risk premia required by investors.On the economics profession
An example of the confidence of the economic profession in this period given by Robert LucasRobert Lucas, Jr.
Robert Emerson Lucas, Jr. is an American economist at the University of Chicago. He received the Nobel Prize in Economics in 1995 and is consistently indexed among the top 10 economists in the Research Papers in Economics rankings. He is married to economist Nancy Stokey.He received his B.A. in...
, in his 2003 presidential address to the American Economic Association
American Economic Association
The American Economic Association, or AEA, is a learned society in the field of economics, headquartered in Nashville, Tennessee. It publishes one of the most prestigious academic journals in economics: the American Economic Review...
, where he declared that the "central problem of depression-prevention [has] been solved, for all practical purposes".
End
Economists speculate that the late-2000s economic and financial crisisFinancial crisis
The term financial crisis is applied broadly to a variety of situations in which some financial institutions or assets suddenly lose a large part of their value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many recessions coincided with these...
may have brought the period of the Great Moderation to an end. Richard Clarida
Richard Clarida
Richard Clarida is an American economist, C. Lowell Harriss Professor of Economics and International Affairs at the School of International and Public Affairs at Columbia University and Global Strategic Advisor for PIMCO. He is notable for his contributions to dynamic stochastic general...
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."
See also
- 1990s United States boom1990s United States boomThe 1990s boom in the United States of America was a period of economic prosperity, largely coinciding with the presidency of Bill Clinton and the Republican Revolution.- The "long boom" :The term "long boom" was also used during the 1990s when the U.S...
- New EconomyNew EconomyThe New Economy is a term to describe the result of the transition from a manufacturing-based economy to a service-based economy. This particular use of the term was popular during the Dot-com bubble of the late 1990s...
- Structural breakStructural breakA structural break is a concept in econometrics. A structural break appears when we see an unexpected shift in a time series. This can lead to huge forecasting errors and unreliability of the model in general...
- Great DepressionGreat DepressionThe Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...
of the 1930s