Is the Great Moderation back?
The Great Moderation — a term popularized by economists — refers to the period from the mid-1980s (1983 or 1984 are common starting points) to 2007 when the economy enjoyed relatively stable growth and prosperity. There were only two historically short and mild recessions (1990-91 and 2001). The stock market boomed. Consumer spending and home-buying rose. Unemployment trended down; in 2006 and 2007, it averaged 4.6 percent.
As regular readers of this column know, I view the Great Moderation as the ultimate cause of the financial crisis and Great Recession. It inspired complacency that the economy had entered a semi-permanent state of stability marked by long expansions and brief recessions. A tamed business cycle signaled less risk. Consumers could assume more debt — and lenders could lend more freely — because repayment prospects had improved. Bankers, economists, government regulators, CEOs, consumers — all subscribed to the logic.
We know now that it was an illusion. When the resulting credit bubble burst, the economy fell sharply. It’s still limping along.
So, how could the Great Moderation have returned? Today’s plodding economy seems the polar opposite. Here’s why.
The Great Moderation involved a smoothing of economic activity. In statistical terms, deviations from the average declined; volatility receded. Now, some economists detect similar patterns in recent years, albeit in an economy still performing well below its potential.
In a speech in April, Jason Furman — head of the White House Council of Economic Advisers — noted that “a number of key data series have exhibited a high degree of consistency and stability since the recovery began in mid-2009.” A report from economists at Goldman Sachs reached a similar conclusion. The Economist magazine, in its May 24 issue, ran an article proclaiming “volatility has disappeared from the economy and markets.”
Translation: Although economic growth is weak, the recovery from the Great Recession still exhibits the statistical steadiness of the Great Moderation. What’s going on?
The Great Moderation 2.0 might be nothing more than a fluke. It reflects a few years of data after the financial crisis (which, of course, was anything but mild and predictable) and might disappear with the addition of a few more years’ data. The theories as to why the economy might have become more stable over the long term are flimsy and — obviously — have to contend with the major exceptions of the financial crisis and Great Recession.
My hunch is that the Great Moderation 2.0 mainly results from mass psychology — but a mood opposite of what came earlier. While the original Great Moderation involved growing confidence and optimism, its successor embodies stubborn pessimism and persistent caution. Almost everyone was scarred and scared by the financial crisis and the ensuing slump. Consumers are not only “deleveraging” (paying down debt) but also trying to build up savings against possible future setbacks. Businesses are reluctant to invest in major expansions because they’re unsure of future demand.
Tougher government regulation, particularly of banks and financial institutions, reinforces this reluctance. Pushing the other way is the loose credit policy of the Federal Reserve. Taken together, all these forces produce steady but slow growth, for the time being. As yet, there are few signs of the self-defeating complacency that preceded the financial crisis, though Fed officials worry about that possibility. But I am skeptical that we’ve entered a renewed phase of more stability, less volatility and fewer surprises. The more intriguing question is: What comes next?
Read more from Robert Samuelson’s archive.