“Great Misunderstandings of the Great Moderation”

Alex Tabarrok is just the latest, but softer, example. He writes:

…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.

My version of his graph also shows the big (50%) reduction in real output growth volatility.

Tabarrok continues:

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.

It seems the “causes of the great moderation” will never be “grabbed”. The reason is simple. People look everywhere, except at the fact that the great moderation began when nominal stability (a concept that is broader than inflation stability) was achieved. According to the graph above, the exact timing can be pinned by the eye (although methods that are more sophisticated arrive at the same conclusion, 1984.II).

The great moderation, however, was more than just strongly reduced real output growth volatility. It also referred to the fact that average real growth was not significantly different from that observed during the high volatility period.

The Table provides the relevant statistics

It appears that between 2006 and 2017, “something” happened. Furthermore, that “something” must have happened between 2006 and 2009.

The next graph shows what did happen. The Fed let nominal spending growth fall down the “chute”, temporarily losing nominal stability.

The “River analogy” is useful:

After falling down the “chute”, the economy lost power. Now the “river” flows at much reduced speed (2.1% vs 3.4%) and is more like a “tranquil pool”, with “wavelets” down by more than 50% to 0.7.

The chart below indicates that both rates and levels are important in separating the “real” from the “fake” great moderation.

The Fed now would have to come up with a “mon pol lift” to take the economy up to the “proper floor”.

No matter that the Fed has major responsibility for this unwarranted outcome. It´s always something or someone’s else´s fault. Krugman expresses the majority opinion:

Paul Krugman

In particular, both Bernanke and Yellen responded effectively to a once-in-three-generations economic crisis despite constant heckling from back-seat drivers in Congress and on the political right in general. And their intellectual and moral courage has been completely vindicated by events.

What are those events, I wonder?


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