The Great Moderation is a period in the

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starting from the mid-1980s until at least 2007 characterized by the reduction in the volatility of

business cycle Business cycles are intervals of expansion followed by recession in economic activity. These changes have implications for the welfare of the broad population as well as for private institutions. Typically business cycles are measured by examin ...

fluctuations in developed nations compared with the decades before. It is believed to be caused by institutional and structural changes, particularly in central bank policies, in the second half of the twentieth century. Sometime during the mid-1980s major economic variables such as real

gross domestic product Gross domestic product (GDP) is a monetary measure of the market value of all the final goods and services produced and sold (not resold) in a specific time period by countries. Due to its complex and subjective nature this measure is of ...

growth, industrial production, monthly payroll employment and the unemployment rate began to decline in volatility. During this period, growth in price levels dropped substantially whilst hourly compensation continued to increase, and

interest rate An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, t ...

s started to fall. The period also saw a large increase in household net wealth and income, whilst wealth inequality increased along various measures. Ben Bernanke and others in the

US Federal Reserve The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after ...

(the Fed) claim that the Great Moderation is primarily due to greater independence of the central banks from political and financial influences which has allowed them to follow macroeconomic stabilisation, by measures such as following the

Taylor rule The Taylor rule is a monetary policy targeting rule. The rule was proposed in 1992 by American economist John B. Taylor for central banks to use to stabilize economic activity by appropriately setting short-term interest rates. The rule consider ...

.Federal Reserve Bank of Chicago, ''Monetary Policy, Output Composition and the Great Moderation'', June 2007
/ref> Additionally, economists believe that

information technology Information technology (IT) is the use of computers to create, process, store, retrieve, and exchange all kinds of data . and information. IT forms part of information and communications technology (ICT). An information technology syste ...

and greater flexibility in working practices contributed to increasing macroeconomic stability.Ćorić, Bruno. "The Sources Of The Great Moderation: A Survey." Challenges Of Europe: Growth & Competitiveness – Reversing Trends: Ninth International Conference Proceedings: 2011 (2011): 185–205. Business Source Complete. Web. 15 March 2014. The term was coined in 2002 by James Stock and

Mark Watson Mark Andrew Watson (born 13 February 1980) is a British comedian and novelist. Early life Watson was born in Bristol to a Welsh mother and English father. He has younger twin sisters and a brother, Paul. He attended Bristol Grammar School, ...

to describe the observed reduction in business cycle volatility. There is a debate pertaining to whether the Great Moderation ended with the late-2000s economic and financial crisis, or if it continued beyond this date with the crisis being an anomaly.

Origins of the term

The term "great moderation" was coined by James Stock and

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 Shalom Bernanke ( ; born December 13, 1953) is an American economist who served as the 14th chairman of the Federal Reserve from 2006 to 2014. After leaving the Fed, he was appointed a distinguished fellow at the Brookings Institution. Duri ...

(then member and later chairman of the

Board of Governors of the Federal Reserve The Board of Governors of the Federal Reserve System, commonly known as the Federal Reserve Board, is the main governing body of the Federal Reserve System. It is charged with overseeing the Federal Reserve Banks and with helping implement the m ...

) in a speech at the 2004 meetings of the Eastern Economic Association.

Causes

Central bank independence

Since the Treasury–Fed Accord of 1951, the

(fed) was freed from the constraints of fiscal influence and gave way to the development of modern monetary policy. According to John B. Taylor, this allowed the Federal Reserve to abandon discretionary macroeconomic policy by the US Federal government to set new goals that would better benefit the economy. The span of the Great Moderation coincides with the tenure of

Alan Greenspan Alan Greenspan (born March 6, 1926) is an American economist who served as the 13th chairman of the Federal Reserve from 1987 to 2006. He works as a private adviser and provides consulting for firms through his company, Greenspan Associates LLC. ...

as Fed chairman: 1987-2006.

Taylor Rule

According to the Federal reserves, following the

results in less policy instability, which should reduce macroeconomic volatility. The rule prescribed setting the

bank rate Bank rate, also known as discount rate in American English, is the rate of interest which a central bank charges on its loans and advances to a commercial bank. The bank rate is known by a number of different terms depending on the country, and ...

based on three main indicators: the federal funds rate, the

price level The general price level is a hypothetical measure of overall prices for some set of goods and services (the consumer basket), in an economy or monetary union during a given interval (generally one day), normalized relative to some base set ...

and the changes in

real income Real income is the income of individuals or nations after adjusting for inflation. It is calculated by dividing nominal income by the price level. Real variables such as real income and real GDP are variables that are measured in physical u ...

. The Taylor rule also prescribes economic activity regulation by choosing the federal funds rate based on the inflation gap between desired (targeted) inflation rate and actual inflation rate; and the output gap between the actual and natural level. In an ''American Economic Review'' paper, Troy Davig and Eric Leeper stated that the Taylor principle is countercyclical in nature and a "very simple rule

hat A hat is a head covering which is worn for various reasons, including protection against weather conditions, ceremonial reasons such as university graduation, religious reasons, safety, or as a fashion accessory. Hats which incorporate mecha ...

does a good job of describing Federal Reserve interest-rate decisions". They argued that it is designed for "keeping the economy on an even keel", and that following the Taylor principle can produce business cycle stabilization and crisis stabilization.Davig, Troy and Leeper, Eric M. "Generalizing the Taylor Principle." American Economic Review. 97.3 (2007): 607–635. Print. However, since the 2000s the actual interest rate in

advanced economies A developed country (or industrialized country, high-income country, more economically developed country (MEDC), advanced country) is a sovereign state that has a high quality of life, developed economy and advanced technological infrastruct ...

, especially in the US, was below that suggested by the Taylor rule.

Structural economic changes

A change in economic structure shifted away from manufacturing, an industry considered less predictable and more volatile. ''The Sources of the Great Moderation'' by Bruno Coric supports the claim of drastic labor market changes, noting a high "increase in temporary workers, part time workers and overtime hours". In addition to a change in the labor market, there were behavioral changes in how corporations managed their inventories. With improved sales forecasting and inventory management, inventory costs became much less volatile, increasing corporation stability.

Technology

Advances in information technology and communications increased corporation efficiency. The improvement in technology changed the entire way corporations managed their resources as information became much more readily available to them with inventions such as the barcode. Information technology introduced the adoption of the "just-in-time" inventory practices. Demand and inventory became easier to track with advancements in technology, corporations were able to reduce stocks of inventory and their carrying costs more immediately, both of which resulted in much less output volatility.

Good luck

There is a debate pertaining to whether the macroeconomic stabilization of the Great Moderation occurred due to good luck or due to monetary policies. Researchers at the US Federal Reserve and the

European Central Bank The European Central Bank (ECB) is the prime component of the monetary Eurosystem and the European System of Central Banks (ESCB) as well as one of seven institutions of the European Union. It is one of the world's most important centra ...

have rejected the "good luck" explanation, and attribute it mainly to monetary policies. There were many large economy crises — such as the Latin American debt crisis of the 1980s, the failure of Continental Illinois Bank in 1984, the stock market crash of 1987, the Asian financial crisis in 1997, the collapse of

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in 1998, and the dot-com crash in 2000 — that did not greatly destabilize the US economy during the Great Moderation. Stock and Watson used a four variable vector autoregression model to analyze output volatility and concluded that stability increased due to economic good luck. Stock and Watson believed that it was pure luck that the economy didn't react violently to the economic shocks during the Great Moderation. While there were numerous economic shocks, there is very little evidence that these shocks are as large as prior economic shocks.

Effects

Research has indicated that the US monetary policy that contributed to the drop in the volatility of US output fluctuations also contributed to the decoupling of the business cycle from household investments characterized the Great Moderation. The latter became the toxic assets that caused the

Great Recession The Great Recession was a period of marked general decline, i.e. a recession, observed in national economies globally that occurred from late 2007 into 2009. The scale and timing of the recession varied from country to country (see map). At ...

. According to

Hyman Minsky Hyman Philip Minsky (September 23, 1919 – October 24, 1996) was an American economist, a professor of economics at Washington University in St. Louis, and a distinguished scholar at the Levy Economics Institute of Bard College. His research ...

the great moderation enabled a classic period of financial instability, with stable growth encouraging greater financial risk taking.

End

It is now commonly assumed that the late-2000s economic and financial crisis brought the Great Moderation period to an end, as was initially argued by some economists such as

John Quiggin John Quiggin (born 29 March 1956) is an Australian economist, a professor at the University of Queensland. He was formerly an Australian Research Council Laureate Fellow and Federation Fellow and a member of the board of the Climate Change Aut ...

Richard Clarida Richard Harris Clarida (born May 18, 1957) is an American economist who served as the 21st Vice Chair of the Federal Reserve from 2018 to 2022. Clarida resigned his post on January 14th 2022 to return from public service leave to teach at Columbi ...

PIMCO PIMCO (Pacific Investment Management Company, LLC) is an American investment management firm focusing on active fixed income management worldwide. PIMCO manages investments in many asset classes such as fixed income, equities, commodities, a ...

considered the Great Moderation period to have been roughly between 1987 and 2007, and characterised it as having "predictable policy, low inflation, and modest business cycles". However, before the Covid-19 pandemic, the US real GDP growth rate, the real retail sales growth rate, and the inflation rate had all returned to roughly what they were before the Great Recession. Todd Clark has presented an empirical analysis which claims that volatility, in general, has returned to the same level as before the

. He concluded that while severe, the 2007 recession will in future be viewed as a temporary period with a high level of volatility in a longer period where low volatility is the norm, and not as a definitive end to the Great Moderation. However, the decade following

had some key differences with the economy of the Great Moderation. The economy had a much larger debt overhead. This led to a much slower economic recovery, the slowest since the

Great Depression The Great Depression (19291939) was an economic shock that impacted most countries across the world. It was a period of economic depression that became evident after a major fall in stock prices in the United States. The economic contagio ...

. Despite the low volatility of the economy, few would argue that the 2009-2020 economic expansion, which was the longest on record, was carried out under Goldilocks economic conditions. Andrea Riquier dubs the post-Great Recession period as the "Great Stability".

References

External links

scholarly articles
{{DEFAULTSORT:Great moderation Business cycle 1990s economic history 2000s economic history 1980s economic history