When the Reagan Boom ended, the Great Moderation began

On July 1 1985, the New Republic published an article by Michael Barker titled “The end of the Reagan boom


What’s going on here? Only a year ago, the economy was racing along at the fastest clip in more than 30 years. Personal income was up, inflation was down, and to many Americans, if seemed positively churlish to deny that President Reagan had succeeded in “laying the foundations for a decade of supply-side growth.”

… now, seven months after the election, just when we thought it was going to be “morning in America” for at least another four years, the forecasts are turning remarkably gloomy. First-quarter economic growth figures were virtually flat, raising fears of a “growth recession”—a period in which economic growth is so slow that unemployment increases anyway.

it’s hard to believe that the Fed’s action alone will be enough to prevent another recession either late this year or early in 1986.

All that blustery growth through 1983 and 1984 was nothing more than the pendulum swing of the business cycle, spurred along by record deficits and a Federal Reserve terrified of a long string of bank collapses.

The coming recession almost certainly will be the result of our big trade and fiscal deficits. No country has ever managed to run trade and budget deficits simultaneously and still sustain a recovery. We’ll be no exception.

On the other hand, the economy probably won’t just bounce back, as it did in 1983.

The likely result will be sluggish growth through 1986 and 1987, punctuated by at least a few quarters of absolute decline.

I take this as another opportunity to elaborate on NGDP Level targeting, hopefully contibuting to the ongoing “Monetary Framework” debate.

The chart shows that “all that blustery growth through 1983 and 1984…” was the outcome of a successful economic recovery engineered by the Fed. Note the “landing was not “soft” or “hard”, but just perfect!

Inflation came down and stayed down even while the Fed undertook an expansionary monetary policy (rising NGDP growth) to get the economy back on track.

Contrary to what Barker anticipated, there was no recession in 85, 86, 87, 88 or 89. During those years as in the subsequent ones, all the way to the end of Greenspan´s tenure, in fact, the economy evolved close to the longstanding trend path (“potential output”). Meanwhile, NGDP growth was very stable and inflation came down further in the early 1990s.

On the 1990-91 recession and simultaneous fall in inflation, in 1996 Orphanides wrote about the “Opportunistic Approach to Disinflation”.

Proponents of this approach hold that when inflation is moderate but still above the long-run objective, the Fed should not take deliberate anti- inflation action, but rather should wait for external circumstances—such as favorable supply shocks and unforeseen recessions—to deliver the desired reduction in inflation.

I don´t think there was anything “opportunistic” about the fall in inflation. Actually, it may have been a surprise. During 1990, the Fed was concerned with the fiscal situation, rooting for the budgetary changes that were being contemplated. At several meetings, the FOMC tied policy easing to progress in the fiscal front.

Then, Desert Storm happened. In the October 1990 FOMC Greenspan stated:

I would say that the appropriate policy under the oil price supply shock is to do what we were doing before–to try in a sense to maintain the same money supply growth pattern we would have had prior to the oil shock, absorbing a lower level of physical activity and a slightly higher level of inflation largely because we can’t avoid either of those two. I would say that the appropriate action is essentially to be where we were. It’s not to be accommodative; it’s not to try to stop the rise in prices, because we can’t.

He didn´t quite do it because NGDP growth slipped. Thereafter, NGDP growth remained very stable.

Ironically, seven years later, in 1997, Bernanke co-authored an article with Gertler: “Systematic Monetary Policy and the Effects of Oil Price Shocks”, concluding:

Substantively, our results suggest that an important part of the effect of oil price shocks on the economy results not from the change in oil prices, per se, but from the resulting tightening of monetary policy. This finding may help to explain the apparently large effects of oil price changes found by Hamilton and many others.

In 2000, the Greenspan Fed made a rare mistake. It let NGDP growth fall significantly and let it remain low for some time. In August 2003, the introduction of Forward Guidance (FG) was sufficient to lift NGDP growth to its “rightful place”. Real output dutifully climbed back to trend!

In my view, the popular notion that “interest rates were too low for too long” has to be amended to “NGDP growth was too low for too long”.

Unfortunately, 10 years after “Systematic Monetary Policy…” Bernanke completely forgot his own conclusion. Monetary policy was “squeezed”, with NGDP growth tanking. The outcome was the “Great Recession” (that morphed, due to absence of a recovery, into the “Long Depression”).

The charts tell the story.


NGDP Targeting has been discussed at the FOMC over the past 35 years.

FOMC Dec 1982

MORRIS. I think we need a proxy–an independent intermediate target– for nominal GNP, or the closest thing we can come to as a proxy for nominal GNP, because that’s what the name of the game is supposed to be.

FOMC Dec 1992

Jordan. I put together a table–a big matrix of every forecast for as many quarters out as the Greenbook does it–for every meeting for the last year. What struck me was that it looked as if we were on a de facto nominal GNP target.

As the chart indicates, he was (and continued to be) “on the mark”.

FOMC Nov 2011

Bernanke (pps 92-93). Thank you very much, and thank you all for your thoughtful comments. Let me make a couple of suggestions and summary remarks. First, on the intermediate targets like nominal GDP and price-level targeting, I didn’t hear much enthusiasm for any near-term adoption, although I think there was at least some interest in continuing to think about these issues perhaps in the context of a significant change in the environment.

Just for interest, I do raise one point, which is that a number of people have mentioned Christy Romer’s piece, and she talked about the 1979 regime change. I actually think that’s the wrong example.

As President Bullard pointed out, when Chairman Volcker changed the policy regime, in fact, it took a long time for people to appreciate it and understand it, and one implication of that is there was a long recession and real interest rates remained very high, and so on.

But there are other examples, like 1933, when Roosevelt took the U.S. off the gold standard, and prices and asset prices changed almost overnight. There are other examples like the end of hyperinflations, and so on.

There’s something sometimes about regime changes that has remarkable effects on an economy. I’m not saying that we know how to predict that, but that’s something that we haven’t really understood or really explored in this conversation. That being said, I think that there was a lot of agreement that there are a lot of practical issues associated with implementing such an intermediate target, including both the very long horizons over which they have to operate and the issues of communication and credibility.

In his book “The courage to act” (pps 517-518) however, Bernanke states:

The full FOMC would discuss NGDP targeting at its November 2011 meeting. After a lengthy discussion, the Committee firmly rejected the idea…

…for NGDP targeting to work it had to be credible. That is, people would have to be convinced that the Fed, after spending most of the 1980s and 1990s trying to quash inflation, had suddenly decided that it was willing to tolerate higher inflation, possibly for many years

The “firmly rejected” was, to put it mildly, an exaggeration!

Furthermore, I didn´t see, in the discussions (neither in those that took place in 1982 and 1992), anyone express the idea that, by adopting NGDP targeting, the “Fed would have to be willing to tolerate higher inflation…”

The Economist made the most scathing comment on that section of the book when it came out in 2015:

And so in January of 2012 the Fed reiterated its inflation-targeting stance and officially designated a 2% rate of inflation, as measured by the price index for personal consumption expenditures, as the target.

We all know what happened next. Since then, the Fed has spectacularly undershot its inflation target. In 2011, most Fed members thought that interest rates would begin to rise in 2014 and would end the year at about 0.75%—and most thought rates would eventually settle at a level between 4-5%. Now, markets suspect rates might not rise to 0.5% until well into 2016, and most Fed members think rates will never get any higher than 3.5%. Treasury prices suggest that inflation will be closer to 1% than 2% over the next five years.

There is good reason to believe that Mr Bernanke’s Fed made a big mistake, in other words. An NGDP target would have worked out better, in two key ways.

First, a switch to an NGDP target would have helped the Fed choose policy more appropriately at a tricky time in the recovery. In 2011 high oil prices drove headline inflation above 2%, despite significant weakness in core inflation, in wage growth, and in the labour market.

In early 2012, at the time the Fed was adopting its inflation target, the central bank sensibly shrugged aside calls to raise rates in response to rising prices. Yet it also took no additional action to boost the economy. The recovery subsequently lost pace, inflation fell, and by the end of 2012 the Fed was forced to restart QE.

Had the Fed instead focused its attention on NGDP, it would have been forced to react to an economy that was well below an appropriate level of output and which was growing too slowly. The Fed could have looked straight through inflation and kept its foot on the accelerator. Instead it took the costly choice to dither.

Just as importantly, a switch to an NGDP target would have sent a strong signal about Fed priorities, precisely because it was a significant departure from past policy-making. Mr Bernanke notes that the Fed spent the 1980s and 1990s trying to quash inflation.

It did not arrive at that policy strategy passively; on the contrary, that strategy was a bold departure from what had come before. Paul Volcker might have argued in the early 1980s that the Fed couldn’t possibly rein in double-digit inflation because it lacked credibility as an inflation-fighter after a decade of neglecting the problem. Instead, he used the tools available to him to demonstrate the Fed’s credibility.

Mr Bernanke’s Fed could have, and should have, taken similarly bold action. It could have set a bold and more effective target and committed itself to unlimited asset purchases until that target was hit. Instead, it made itself a prisoner of its own complacency. As a result, inflation and interest rates will spend most of the 2010s at dangerously low levels, leaving the American economy disconcertingly vulnerable to new economic shocks.

At the same time, Brad DeLong found himself thinking about six things :

# 6: The failure of the Bernanke Fed to admit that the 2%/year inflation target had proved to be a mistake, and shift to a more sensible nominal GDP target.

To wrap up, the charts show the heavy costs imposed by Bernanke´s “dangerous” obsession with inflation targeting.


The first oil shock happened mostly under Greenspan. As expected (headline) inflation goes up and real growth slips. However, Greenspan kept NGDP growth stable, avoiding the worse (as he had said in 1990).

Bernanke, however, contrary to his academic research, tightens monetary policy. NGDP growth turns down and then tanks.

We are reminded of James Meade´s 1977 Nobel Lecture:

Earlier I spoke of ‘price stability’ as being one of the components of ‘internal balance’. Yet in the outline which I have just given of a possible distribution of responsibilities no one is directly responsible for price stability.

To make price stability itself the objective of demand management would be very dangerousIf there were an upward pressure on prices because the prices of imports had risen or because indirect taxes had been raised, the maintenance of price stability would require an offsetting absolute reduction in domestic money wage costs; and who knows what levels of depression and unemployment it might be necessary consciously to engineer in order to achieve such a result?


I have told this particular story simply to make the point that the choice between fiscal action and monetary action must often depend upon basic policy issues which should certainly be the responsibility of the government rather than of any independent monetary authority.

Perhaps the best compromise is an independent monetary authority charged so to manage the money supply and the market rate of interest as to maintain the growth of total money income on its 5-per-cent-per-annum target path, after taking into account whatever fiscal policies the government may adopt.


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