Brief History of Macroeconomic Thought and Policy
3. Macroeconomics for the 21st Century
Is the Great Moderation Over?
As did the Great Depression of the 1930s, the Great Recession of the late 2000s generated great fear. Even though it officially ended in the middle of 2009, the state of the economy was the major issue over which the 2012 U.S. presidential election was fought, as the two major political parties offered their competing visions. Unemployment was still high, the housing sector had still not recovered, and the European debt situation loomed in the background. Another lurking question was whether the experience of the recent deep recession, the related financial crisis, and the slow recovery from them would become the new "normal" or whether macroeconomic performance would return to being less volatile.
Economist Todd Clark at the Federal Reserve Bank of Kansas attempted to answer this question. He first looked at the various explanations for the lower volatility of the U.S. economy during the 25-year period that preceded the Great Recession. Three broad reasons were given: structural changes, improved monetary policy, and good luck. While there is disagreement in the literature as to the relative importance of each of these, Clark argues that there is no reason to assume that the first two explanations for moderation will not continue to have moderating influences. For example, one positive structural change has been better inventory management, and he sees no reason why firms should become less able in the future to manage their inventories using the newly developed techniques. Similarly, in the future, monetary authorities should be able to continue to make the better decisions that they made during the Great Moderation. The element that can vary is luck. During the Great Moderation, the economy experienced fewer serious shocks. For example, oil prices were fairly stable. In contrast, during the recent recession, the price of oil rose from $54 per barrel in January 2007 to $134 per barrel in June 2008. The bursting of the housing price bubble and the ensuing crisis in financial markets was another major shock contributing to the depth and length of the recent recession. Clark says, "Accordingly, once the crisis subsides and the period of very bad luck passes, macroeconomic volatility will likely decline. In the future, the permanence of structural change and improved monetary policy that occurred in years past should ensure that low volatility is the norm". Let's hope that he is correct.