Definition and Timeline
The Great Moderation refers to a period from the mid-1980s to the financial crisis in 2007 when the United States experienced decreased macroeconomic volatility. During this time, the U.S. economy demonstrated more stable growth, subdued inflation, and fewer severe recessions compared to previous decades.
Causes of The Great Moderation
Improved Monetary Policy
One of the main contributors to the Great Moderation was the improvement in monetary policy, primarily under the leadership of Federal Reserve Chairman Paul Volcker and his successors. A focus on controlling inflation through interest rate adjustments played a significant role.
Structural Changes in the Economy
Structural changes, such as technological advancements and improvements in supply chain management, enhanced the flexibility and efficiency of the production processes.
Financial Innovation
The period also saw significant financial innovations, including the development of new financial instruments and risk management techniques that contributed to economic stability.
Implications of The Great Moderation
Benefits
1. Economic Growth: The U.S. experienced prolonged periods of economic growth with fewer and milder recessions. 2. Inflation Control: Better control of inflation maintained purchasing power and stabilized the financial environment. 3. Improved Living Standards: Steadier employment rates and economic growth led to improved living standards for many Americans.
Criticisms and Downsides
1. Overconfidence in Stability: The perception of stability led to increased risk-taking behavior in financial markets. 2. Inequity in Economic Benefits: Not all socioeconomic groups benefited equally, which led to increased wealth disparities. 3. Build-Up to the 2008 Financial Crisis: The sense of security and the resulting risk-taking behaviors contributed to the conditions that precipitated the 2008 financial crisis.
Historical Context
Preceding Economic Volatility
Prior to the Great Moderation, the U.S. economy faced high inflation and significant economic disruptions during the 1970s and early 1980s, including the oil shocks and the stagflation period.
The Aftermath
The 2007 financial crisis marked the end of the Great Moderation. The subsequent recession revealed the vulnerabilities that had built up during the previous period of perceived stability.
Applicability and Modern Comparisons
Lessons for Current Economic Policy
Policymakers analyze the Great Moderation to understand how to balance inflation control and economic growth, alongside adequate regulation to prevent financial excesses.
Related Economic Phenomena
- The Roaring Twenties: A previous period of economic growth and stability in the U.S. during the 1920s, followed by the Great Depression.
- The Dot-Com Bubble: Another era of financial innovation that led to an economic boom followed by a bust.
FAQs
Q1: What marked the end of the Great Moderation?
The Great Moderation effectively ended with the onset of the financial crisis in 2007, which highlighted significant flaws and risks that had accumulated over the period.
Q2: How did technological advancements contribute to the Great Moderation?
Technological advancements led to better supply chain management, increased productivity, and more efficient production processes, contributing to economic stability.
Q3: Were there any global impacts of the Great Moderation?
Yes, the policies and practices that contributed to the Great Moderation in the U.S. often had international ripple effects, influencing global economic stability and practices.
References
- Bernanke, B. S. (2004). “The Great Moderation.” Speech at the Eastern Economic Association, Washington, DC.
- Stock, J. H., & Watson, M. W. (2002). “Has the Business Cycle Changed and Why?” NBER Macroeconomics Annual 2002.
Summary
The Great Moderation represents a crucial period in U.S. economic history characterized by reduced macroeconomic volatility, significant policy improvements, and technological advancements. While it brought about stable growth and controlled inflation, it also led to increased risk-taking behaviors that contributed to the 2008 financial crisis. Understanding this period helps inform current economic policies to strive for sustainable economic stability.
