Great Moderation

Published Mar 22, 2024

Definition of The Great Moderation

The Great Moderation refers to a period of significant reduction in the volatility of business cycle fluctuations in major economies, notably in the United States, which spanned from the mid-1980s until the financial crisis of 2007-2008. This era was marked by sustained economic growth, low inflation rates, and relatively mild recessions, compared to the more severe economic downturns experienced in the preceeding decades.

Example

One of the most telling examples of the Great Moderation is the performance of the U.S. economy during the late 20th and early 21st centuries. During this period, the U.S. experienced longer economic expansions and shorter, less severe recessions than in the past. For instance, the recession of 2001, triggered by the bursting of the dot-com bubble, was notably mild and short-lived compared to the deep recessions of the 1970s and early 1980s. The period saw improvements in monetary policy practices, more effective financial market regulations, and the globalization of economies, which together contributed to this increased economic stability.

Why The Great Moderation Matters

The significance of the Great Moderation lies in its impact on economic policy, theory, and the global economy. For policymakers, the apparent reduction in economic volatility provided a different backdrop for monetary and fiscal policy, with a greater emphasis placed on inflation targeting and a reduced focus on cyclical adjustments. Economists also revisited theories on business cycle dynamics, incorporating insights about how structural changes and policy improvements might have led to better economic outcomes. For the global economy, the Great Moderation indicated a period of relative predictability and stability, which encouraged cross-border trade and investment, fueling globalization and economic integration.

Frequently Asked Questions (FAQ)

What factors contributed to the Great Moderation?

Several factors have been credited with contributing to the Great Moderation. Improved monetary policies, particularly by the Federal Reserve, played a significant role. Central banks became better at managing inflation expectations and responding to economic shocks. Technological advancements, especially in information and communication technologies, enhanced productivity and allowed for more efficient supply chain management. Globalization also played a role by expanding markets, allowing for more efficient allocation of resources, and exerting downward pressure on prices. Additionally, some argue that good luck in the form of fewer significant external economic shocks also played a role during this period.

Did the Great Moderation end with the Financial Crisis of 2007-2008?

Many economists agree that the financial crisis of 2007-2008 marked the end of the Great Moderation. The crisis unveiled significant vulnerabilities within the financial system and the economy, leading to the Great Recession—the deepest and most prolonged economic downturn since the Great Depression. The crisis challenged the perception that the era’s lower economic volatility would persist, and it has led to a reevaluation of the factors that contributed to the Great Moderation, including the role of financial market deregulation and the management of systemic risk.

Can the Great Moderation be recreated, or was it a unique period unlikely to be repeated?

Opinions differ on whether the conditions of the Great Moderation can be recreated. Some believe that with sound economic policies, including prudent financial regulation, effective monetary policy, and measures to enhance economic flexibility, it’s possible to achieve a period of sustained low volatility in economic activity. However, others argue that unique factors, including the specific geopolitical context of the late 20th and early 21st centuries and certain technological advancements, mean that the Great Moderation was a unique period unlikely to be precisely replicated. Future economic stability may require addressing contemporary challenges such as globalization’s discontents, the digital economy’s implications, and climate change.