The Great Moderation Never Ended

by on October 26, 2017 at 7:24 am in Economics | Permalink

In 2002, Stock and Watson pointed out that the volatility in the growth rate of real GDP between 1984 and 2001 was much lower than it had been between 1960 and 1983, a phenomena dubbed the great moderation. In 2004, Ben Bernanke credited better monetary policy for the great moderation–meaning, of course, better monetary policy under Volcker, Greenspan and (Governor and later Chair) Bernanke. Other people credited sectoral changes in the structure of the economy such as the shift away from volatile sectors like manufacturing to less volatile sectors like health care. Improved information technology that led to better inventory control and smoother adjustments is another explanation. Some even argued that the great moderation was due to financial innovation! Yet others said it was just dumb luck. The dumb luck view got a boost with the great recession in 2008. Subsequently, many people mocked the idea of the great moderation and those who had tried to take credit.

Yet it is now clear that the great recession interrupted but did not end the great moderation. Since the great recession ended, growth in real GDP has been much less volatile than in the 1950s to 1980s. Indeed, volatility has been lower even taking into account the great recession. In the graph, for example, I simply bound the peaks and valleys. More sophisticated measures show the same thing.

Of the possible explanations, we can now rule out luck. The economy isn’t confronted with fewer shocks than in the past but rather we are adjusting to shocks more successfully. Overall, however, I’d say the causes of the great moderation are still up for grabs.

One problem with most of the theories is that they predict more moderation over time. Manufacturing has continued to decline as a share of GDP, for example. Information technology has gotten much better since 1984. Financial innovation has, if anything, increased in scope. If you squint maybe the great moderation has gotten a bit more moderate over time but that isn’t clear.

Better monetary policy does fit the data in the sense that it could have been a one-time learning (thank you Milton Friedman). But I find it difficult to believe that policy makers are so much wiser than in the past or even that monetary policy has that much influence over the real economy. We also have to grapple with the fact that many countries have experienced a great moderation. In my view this pushes towards an explanation on the real side of the economy, albeit that is a judgment call that the world is more similar in real factors like technology than it is in policies.

We can rescue some of the real theories with limits or endogenous offsets. Inventory control, for example, can only get so good and not better. I find this plausible but it would be more convincing if we could pinpoint the key innovation. Some financial innovations might reduce volatility but ala Minsky also cause people to take more risks (an endogenous offset). That too has some plausibility but again it would be better if we could pinpoint which were the volatility decreasing innovations and which the volatility increasing innovations.

It’s striking that the great moderation never ended and we still have no solid explanation for why it happened.

1 rayward October 26, 2017 at 7:38 am

The difference is that wages have been flat and, hence, “inflation” has moderated, and with a moderation in “inflation”, the Fed hasn’t taken the economy on a roller coaster. Of course, “inflation” is mostly viewed from the perspective of rising wages (not rising asset prices, such as stocks and real estate); thus, in 2008, Larry Summers (in his Okun Lecture) can credit himself and other smart economists with having overcome the Phillips Curve dilemma. Today, those smart economists have bequeathed an economy with both low “inflation” (i.e., flat wages) and rising asset prices, surely the greatest achievement economists have ever produced. Well, greatest if one owns lots of assets, but not so great if one depends on wages.

2 A Truth Seeker October 26, 2017 at 7:38 am

The American Dream has gone sour for most Americans. Johnny can’t read. The drugs epidemics swalled entire communities whole. Violence is out of control. America is more divided that it has ever been. Israel and the wahhabists dictate American foreign policies while communism overruns Indochina and the Korean Peninsula. According to famous American thinker Mr. Kupelian, America has become bizarre. According to Mr. Krugman (awarded with the Prize in Economic Sciences in Memory of Alfred Nobel), America may already be a failing state.
Red China is today more powerful than it has ever been. Trumps promises of getting America’s jobs back sound hollow. The Russian refime is today more powerful than it has ever been since the 1980s. Americans can’t even decide what thay want regarding healthcare.

3 Real Talk October 26, 2017 at 11:41 am

You should readmit yourself to the mental hospital.

4 Napolean Symphony October 26, 2017 at 12:01 pm

A girl cowered along a stake fence, her dress lilted on the tawny sand, folds of pink heavy. She hunched forward on her hands, her fingertips under the beach, her countenance hidden by the distance.

5 A Truth Seeker October 26, 2017 at 12:42 pm

I have never been admited to a mental hospital. Although mental disease can happen to anyone, see the cases of famous mathematician John Nash and Nebuchadnezzar, the king who taught he was a wild beast, I am pretty certain of my mental faculties. I can stack my brain against anyone’s anytime.

6 Speaking Truth to an Idiot October 26, 2017 at 9:37 pm

Your mommy needs her ‘puter back. Be a good a child and go out and play in traffic.

7 The commenter has no name October 26, 2017 at 7:39 am

If I saw that graph in any other context, I would say the frequency or method the variable was measured changed after about 1984. Are we sure something didn’t change then?

8 harpersnotes October 26, 2017 at 7:53 am

Perhaps demographics might help explain the real economy influence and some of the international occurrence? Aging populations, out of college, mostly settled into jobs and careers, and having fewer kids / less household formation? Choosing 1984 as the start, Boomers born in 1954 would have been 30 years old.

9 Toby October 26, 2017 at 8:02 am

Perhaps what has declined is not the volatility of growth but the variance in the measurement of growth. A decline in the variance of measurement error is consistent with a worldwide decline over time. This is technology that can easily spread.

This is also testable. Measurement error leads to attenuation bias. Has attenuation bias declined over time: ie have relationships between real variables become stronger?

10 rtd October 26, 2017 at 8:43 am

You claim that “In 2004, Ben Bernanke credited better monetary policy for the great moderation–meaning, of course, better monetary policy under Volcker, Greenspan and Bernanke.” This despite the fact that Bernanke was a fed governor at the time of the Feb2004 speech you link to and he wasn’t governor until Feb2006.

11 Alex Tabarrok October 26, 2017 at 9:39 am

True, clarified.

12 Becky Hargrove October 26, 2017 at 8:48 am

It’s the dominant services apparatus that reduces volatility, particularly non tradable sector time based services, where utilization capacity responds differently (indirectly) to monetary shocks than what takes place via the direct response of tradable sector activity.

13 josh October 26, 2017 at 8:54 am

Measurement became more biased toward moderation?

Does anyone think “real GDP” measurements are measuring anything that can meaningfully be distinguish a percentage or two?

14 SamChevre October 26, 2017 at 9:28 am

the growth rate of real GDP between 1984 and 2001 was much lower

Shouldn’t this be:
the volatility in the growth rate of real GDP between 1984 and 2001 was much lower

15 mkt42 October 26, 2017 at 2:34 pm

I was going to make the same comment, but Alex has now fixed it.

16 Brian Donohue October 26, 2017 at 9:55 am

The larger, countercyclical welfare state that began with The Great Society has produced less bumpy, but lower growth.

If the theory is correct, a country like France, with its larger welfare state, would be a more extreme version of this phenomenon. I think it is.

Today, the economy is not overextended and can likely continue to churn out steady if unspectacular 2% growth indefinitely, as long as the monetary authority doesn’t screw it up. Yellen deserves credit to date so far, erring only a bit on the tight side, but that is where the greater danger is right now in all the developed world. Lars Christensen has the best takes on this subject.

17 Matthew Young October 26, 2017 at 9:59 am

Declining growth, it is right there in the charts.

Less real growth, less volatility. great idea, lower growth, but there is some doubt that we can sustain a zero growth, we would be moderately dead. I suppose we could try negative growth, teach everyone to walk backwards.

18 Doug October 26, 2017 at 10:36 am


The variance of 0*X is 0. There’s less variance in growth because there’s less growth.

A combination of NIMBY omni-regulation, paralyzed culture, and greying demographics has nearly eliminated any form of large scale risk taking. In the 1950s they were building nuclear power plants, mass-distributing jet aircraft, and eradicating polio and typhoid. Try accomplishing any of that today with the modern-day NRC, FAA, and FDA. The fast available jet travel is slower than it was 30 years ago. Let alone nuclear power, we can’t even build subways. At least not for 40 times the cost that our ancestors did with the technology of a hundred years ago. Heck even new roads and houses are increasingly a challenge to construct with modern-day risk aversion, and new supply is asymptotic to zero.

So the explanation seems pretty simple. Substantially less risk-taking on a micro-level translates into significantly less macro volatility.

19 BC October 26, 2017 at 10:19 am

“But I find it difficult to believe that policy makers are so much wiser than in the past or even that monetary policy has that much influence over the real economy. We also have to grapple with the fact that many countries have experienced a great moderation.”

I thought it was pretty much consensus view that monetary policy was responsible for the Great Moderation, Great Depression, and Great Inflation?? The fact that many countries have experienced great moderation coincident with having adopted inflation targeting would seem to favor, rather than call into question, monetary explanations. If one blames the Fed for the instabilities of the Great Depression and Great Inflation, then isn’t one implicitly saying that, if the Fed did something different, then those instabilities wouldn’t have happened? The Great Moderation is the Fed doing something different. Monetary policy may not have any influence over the real economy in the long run, but I thought its influence on economic cycles in the short run was commonly accepted, no?

20 Tom Warner October 27, 2017 at 1:20 pm

+1 while accepting there is also truth to the idea that we have offshored some of our manufacturing volatility. As you likely have noticed the bloggers here are wearing RBC-inspired blinders.

21 rayward October 26, 2017 at 10:36 am

Is capitalism, as it is practiced today, at war with itself?

22 Al October 26, 2017 at 10:43 am

This coincides with the rise of IT. Perhaps individual firms are simply better managed due to better information afforded by IT.

23 The Cuck-Meister General October 26, 2017 at 12:23 pm

Perhaps its due to the prevalence of cuckolds such as yourself. The increasing number of cuckolds in society seems to be causing everything to go a bit limp.

24 Adamo October 26, 2017 at 11:18 am

“But I find it difficult to believe that policy makers are so much wiser than in the past or even that monetary policy has that much influence over the real economy.”

Ahem – I’ll just quote Bernanke’s speech on Milton Friedman’s 90th birthday: “Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

25 Patito October 26, 2017 at 11:27 am

Maybe the advent of cellular technology? Beepers into phones? If it’s not the measurement error it’s got to be something very general that affects everyone worldwide… so not monetary policy 😛

26 A Truth Seeker October 26, 2017 at 11:29 am

While America stagnates, it is Morning in Brazil. The stock market skyrockets, people get jobs, foreign investment is coming, the reforms are marching like a goose and public business are being sold at amprofit.

What can I say, “North is North and South is South, and never the twain shall meet.”

27 Mama Ribeiro October 26, 2017 at 11:45 am

Honey, please come inside now and stop bothering the grownups….

28 The Cuck-Meister General October 26, 2017 at 12:41 pm

should be “stop bothering the cuckolds”.

29 A Truth Seeker October 26, 2017 at 12:46 pm

Who are the grownups?! Those who shipped American jobs to China? Those who destroyed America’s middle class? Those who, again and again, surrendered to Beijing and sold their children’s future to Moloch for a moss of pottage? Those whose bread has become ashes and the whose silver has become dross? I don’t think so.

30 The Cuckmeister-General October 26, 2017 at 12:49 pm

The cucks are squabbling again.

31 mulp October 26, 2017 at 12:56 pm

Listen, I’m the board nutcase. Stop stealing my gig.

32 A Truth Seeker October 26, 2017 at 1:36 pm

I am not a nutcase. I am considered very reasonable.

33 rayward October 26, 2017 at 12:14 pm

All one need do is look at the trajectory of China’s economy as measured by its GDP, which rose from less than $200 billion in 1980 to over $11 trillion in 2016, the growth commencing in the 1980s but accelerating after 2000. The 1980s were pivotal due to a declared policy of a “strong” dollar (achieved in part by historically high interest rates). Paul Volcker is often credited with having “saved” the U.S. economy. Really? Would the China Miracle have occurred absent Volcker’s heroics? Probably. But on a much more gradual path. The return to a more historic level of interest rates after the 1980s helped put the U.S. back on a path of GDP growth but at a much lower rate than in China, due in part (since 2007) to the Great Recession and worldwide demand for safe (U.S.) assets. I’m not blaming Regan’s “strong” dollar and Volcker’s heroics alone for the enormous shift in production to China and elsewhere, but they provided the trigger that put us on the path, the path having been reinforced by the Great Recession.

34 George October 26, 2017 at 12:16 pm

I used to think that the answer was far better control over inventories, etc. due to the computer/software revolution. But this picture has 3 distinct periods: 1) up to 1982 it is volatile with high levels swings between boom and bust. From 1982 to roughly 2000 there was low volatility in growth rates but high and sustained growth rates. From 2000 on, still moderate but markedly lower growth. It is as if a switch was flipped in 1982 and then another one in 2000.

I don’t see a gradual change that might be explained by gradual improvements in processes or policy. I see sudden change. An explanation for that would be rather different than if the change happened gradually.

35 Albigensian October 26, 2017 at 12:33 pm

” I find it difficult to believe that policy makers are so much wiser than in the past”

Well, Keynesianism seemed to work pretty well (in the USA and Western Europe, anyway) after WWII. Until it didn’t, and governments found themselves dealing with both high inflation and high unemployment.

But, the illusion that the economic Wizards Behind the Curtain had tamed the business cycle must have been powerful indeed. For who wouldn’t want to believe that policy makers are, indeed, so much wiser (aka “this time it will be different”)?

36 tisch October 26, 2017 at 1:27 pm

Not a new idea really, see this post by Coibion and Gorodnichenko from seven years ago:

See also their AER article on the same topic.

37 mkt42 October 26, 2017 at 2:44 pm

Perhaps the reason that volatility has ceased declining is because it cannot decline any more? I.e. analogous to NAIRU, there’s a “natural volatility” in the economy, and after we’ve eliminated the volatility-increasing phenomena such as misguided attempts at countercyclical government policies, overly volatile inventories, etc. then we’ve reduced the volatility as much as it can be at least for the moment.

This is of course a post hoc explanation, and it doesn’t help us predict when or if volatility will change. But it doesn’t seem unreasonable to think that there’s a limit to how low volatility can befor a given economy.

38 Ray Lopez October 26, 2017 at 2:58 pm

@mkt42 – that’s right, the nanny state is to blame. The ‘misguided attempts’ might also not be government induced, except indirectly, and more likely the direct cause is lack of innovation (the ‘home runs’ in my comment downstream).

39 Ray Lopez October 26, 2017 at 2:56 pm

It’s so obvious to anybody who has a background in physics: if a natural process that cycles has amplitudes that get smaller over time, the steady state component often dominates and the transient component dies down, hence volatility decreases. Any exponentially decaying periodic function comes to mind.

Translation for you without a math background: Great Stagnation means ‘no more home runs’ hence the economy is rather tame, real GDP does not jump around a lot.

Bonus trivia: yesterday’s World Series game–I only saw the box score online live–was rather exciting. I wonder if the umpires are adjusting the strike zone to let the team that’s behind “catch up” for a more exciting game? And the umps probably wanted the Astros to even the score, so they ‘let them win’ (called the strike zone tighter when needed).

40 rayward October 26, 2017 at 3:20 pm

It appears to be down to a choice between John Taylor and Jay Powell for Fed Chair. Taylor is the favorite of the inflationistas. If Taylor (who prefers a rules-bound approach to monetary policy – thus, the Taylor Rule) is chosen, would he be more assertive in fighting “inflation” by taking a broader view of its meaning, giving greater attention to rising asset prices (stocks, real estate, etc.) rather than focusing so much on rising wages? As the WP article points out, “Trump has said he likes having low interest rates,” so why in the world would he be considering Taylor. Pence prefers Taylor according to the article. Does Trump even know anything about Taylor? Maybe Trump believe Taylor looks like a Fed Chair, with that gray hair and eye glasses. And he does have that rule named for him.

41 Donald Pretari October 26, 2017 at 6:45 pm

How do wars figure in ?

42 Scott Grannis October 27, 2017 at 3:24 pm

Maybe the significant amount of volatility prior to 1984 was just the result of faulty measurement and/or statistical techniques. I find it difficult to believe that the massive US economy could actually stop, start, and lurch between 0 and 10% growth rates routinely from quarter to quarter.

43 Boonton October 28, 2017 at 8:18 pm

“Better monetary policy does fit the data in the sense that it could have been a one-time learning (thank you Milton Friedman). But I find it difficult to believe that policy makers are so much wiser than in the past or even that monetary policy has that much influence over the real economy. We also have to grapple with the fact that many countries have experienced a great moderation. In my view this pushes towards an explanation on the real side of the economy, albeit that is a judgment call that the world is more similar in real factors like technology than it is in policies.”

I’m not sure I get this. If we are no wiser in terms of monetary policy today than in the past then we owe no thanks to Milton Friedman. I know there’s been a lot of criticism of economics as a science but hey at a min. any science has to go for cumulative learning. NASA may not have an Einstein or Newton but their scientists are actually better in terms of what they can do *because* they stand on the advances of those.

For the record we have a very broad and general knowledge that serious inflation is something a central bank *should* be able to resist. We also know that a central bank should not be bending knee to a Nixon like Executive who tries to direct ‘no recessions’ leading up to an election. Even for countries that don’t quite know that, floating exchange rates means currency can depreciate quickly if it seems one country has adopted an especially silly monetary policy. So I could view whatever its failings we’ve moved past a ‘one time learning’ to avoid a purely stupid monetary policy that either sends us off in an inflationary spiral or tries to respond to a recession by tightening its way out of it. That has to account for some moderation.

44 mkt42 October 28, 2017 at 8:53 pm

Yup. We still don’t know how to stop or even predict economic recessions, but since the 1970s (and the 1930s) we have learned how to prevent them from turning into the next Great Depression (we were headed for another one in 2008 but thankfully it was only a Great Recession instead — i.e. we still have a lot to learn about macroeconomics, but we have certainly learned a fair amount). And we have also learned how to avoid not just hyperinflation but moderate inflation as well.

Ruinous inflation is now only found in countries with clearly incompetent or dishonest governments, e.g. Zimbabwe and Venezuela. Even persistent double-digit inflation is found only in countries with weak leadership. And the Great Recession showed that we still have a lot to learn, but bad as it was it had just a fraction of the negative impact that the Great Depression did.

Those are not inconsiderable advances, even while we must acknowledge our massive ignorance about how macroeconomies work.

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