What is excellent moderation?

The 1980s saw the Great Moderation, a period of reduced macroeconomic volatility in the U.S. Former U.S. Federal Reserve Chair Ben Bernanke claimed a 50% decrease in quarterly real GDP standard deviation and a two-thirds decrease in inflation standard deviation during this period. Multi-decade-low inflation and sound economic growth define the Great Moderation.

Understanding

Moderation occurred after the volatile economic performance and inflation in the U.S. The years leading up to the Great Moderation saw economic ups and downs, including the 1960s Vietnam War inflation, the fall of Bretton Woods, the 1970s stagflationary recessions, and the early 1980s double-dip recession with variable interest rates and inflation.

The moderation saw low and steady U.S. inflation and light recessions.

Fed Portrays Great Moderation

Paul Volcker, Alan Greenspan, and Ben Bernanke’s monetary policy framework led to the Great Moderation. Bernanke proposed three factors for moderation in a 2004 speech: economic structural change, improved policies, and chance.

Bernanke cited structural developments such as increasing computer usage for correct business decisions, financial system advancements, deregulation, a move towards services, and trade openness.

According to Bernanke, improved macroeconomic policies have moderated the prior boom and bust cycles, and analysts attribute the gradual stabilization of the U.S. economy to more sophisticated monetary and fiscal policies. Bernanke concluded that reductions in economic shocks rather than lasting improvements in stabilizing mechanisms had led to increased stability.

Many consider Bernanke’s remarks prematurely self-congratulatory.

The Great Moderation Failed

A few years after Bernanke’s speech, the moderation ended abruptly with the financial crisis and the Great Recession. Due to the Fed’s cheap money policies throughout the Great Moderation, economic imbalances built up over years or decades. In early 2008, the U.S. housing market crashed, and price inflation rose, freezing credit and liquidity in financial markets and causing the worst global recession since the Great Depression.

This was conceivable because the Moderation broke monetary policy feedback mechanisms. Globalization, interconnected financial markets, and the U.S. dollar’s hegemony in international trade gave the Fed’s decades-long inflationary policies an outlet in foreign markets that absorbed price inflation that would have rapidly driven up the domestic price level and spoiled the Fed’s party. During each recession during the Great Moderation, the Fed opted to print more money to mask underlying economic issues.

Instead of letting mild recessions run their course, Fed officials risked a catastrophic crash during the Moderation period to delay short-term suffering.

As if given painkillers and told to keep walking on a broken leg, the economy struggled through modest recessions in the early 1990s and 2000s until it snapped in 2008. The Fed and others’ frail economies from the Great Moderation collapsed in a worldwide crisis.

Conclusion

• Moderation was when U.S. macroeconomic volatility diminished from the mid-1980s to the 2007 financial crisis.
• Bernanke proposed three explanations of the Great Moderation in a 2004 speech: structural change, improved economic policy, and chance.
• The Great Moderation ended in the most significant global crisis since the Great Depression, so Bernanke’s applause was premature.