There’s been plenty of talk in recent weeks that a recession is coming (or that we are already in recession). Indeed, the latest reading from InTrade.com suggests that there is about a 70 percent chance of a recession – defined as two consecutive quarters of negative economic growth – in 2008.
It is an interesting story, but today’s pessimism does not sit easily with the general optimism of macroeconomists over the past decade or so (a point made by David Leonhardt in the Times). Researchers have dubbed the period since the mid-1980′s “The Great Moderation,” arguing that while the business cycle may not have been beaten, it has certainly lost its bite. Careful studies of this transformation suggest that the ups and downs of the business cycle have been dramatically dampened since around 1984. Since then, nearly all measures of economic activity have become less volatile. The forces behind this moderation remain something of a puzzle, but they extend beyond monetary policy, and hence, this is not just a Greenspan effect.
The graph below shows that the amplitude of the business cycle roughly halved since the mid-1980′s. And yet the commonly-used yardstick of a recession (two quarters of negative economic growth) remains unchanged. This observation should give some optimism that even the confluence of several factors slowing the economy may not trigger a recession.
So this brings me to my question: are those who are using the R-word suggesting that the “Great Moderation” is over, or simply that we are facing an especially unusual set of adverse business conditions? Or was there never any real change in the structure of the economy, and the last couple of decades have been simply a statistical fluke?
My guess is that different answers to these questions can explain why some forecasters have divergent forecasts. But I have been surprised by the failure to speak directly to these questions, as the long-run implications of the competing explanations are important and very, very different.
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I’m betting against recession on my Intrade account. I don’t think we’re going to see a recession. The problem is that the moderated economy of the past 25 years has lowered our threshold for pain. So growth slows, or we even have a month or two of negative growth. That sucks, but not as bad as the downturns of the previous 300 years of the American economy (before the moderation). The media (and therefore the public & the politicians) are making this out to be worse than it really is.
Just about every system has a threshold, or peak capacity on this planet, be it in terms of resources and population, population and space, size or any number of factors that we measure as a characteristic or product of that system. Could the Moderation simply be a result of separate dynamic economic systems (the nation state) merging into the global system? Or could it be that given the natural resources at our disposal, labor and infrastructure that the global US economy is peaking or nearing a naturalized systematic threshold of growth? Perhaps. Perhaps uninterrupted growth is a realized dream, I’m not that smart and I don’t have enough historical examples to point to a threshold for our current situation- as we in the United States have far surpassed Cyrus’ Persian Empire, Caesar’s Roman Empire or Victoria’s British Empire.
But there are real physical limits to how many people we can support with current economic systems and the depletion of natural resources (like arable land) despite improvements in technology that continue to increase gains. But even a steroid doped baseball player can only hit so many homeruns. As a maxim, there are limits to just about everything… including matter in the universe.
Is it possible that we were mis-estimating GDP during the high inflation years from late 60s to the early 80s? High inflation may lead to a larger error variance in the measurement of both nominal and real GNP. Hence wilder swings in measured “real” GNP. Thus, part of the great moderation is also lower inflation and possibly even underestimation of real GNP growth in the 90s (cf. R. Gordon or Baumol on quality adjustments in a period of real technical change).
Not saying that there isn’t something going on, but an adjusted measure might show a more gradual shift from the 70s to the late 80s and 90s.
I read this post three times. Then I called my husband over and he read it once. My sister came over and she read it twice and then so did my mother. We all had the same questions: If we all make about 75,000 a year – not combined – at least not yet! what does all this mean to us. More to spend or less to spend? Will we be colder in the winter and hotter in the summer? Can we go to see Uncle Charlie in Florida by car? Will Briana have crooked teeth the rest of her life? Should we start buying Pete the dog that cheap dried food? Should we wait to make out our yearly charity checks? And, when will be get our rebate checks?
Lyn LeJeune – The Beatitudes Network-Rebuilding the Public Libraries of New Orleans and “All May Not Be Well; And All May Not Be Well; And All Manner of Things May Not Be Well,” at http://www.beatitudesinneworleans.blogspot.com
If we are amid a Great Moderation, I suspect that it is largely because Congress didn’t get too excited about the little ups and downs that we’ve seen over the past 30-odd years. Now, with Congress intent on passing an economic package to stimulate the economy, I suspect that the moderation will end, first with inflation and then with a recession worthy of the name. I, for one, am praying for gridlock.
I was not aware that the intrade contracts were actually based on two consecutive quarters of negative economic growth until recently when I read the fine print, but when I learned that, I had a harder time believing those estimates. I’ve been reading more about a slowdown, possibly positive growth but still low, and hadn’t really seen as much of people forecasting negative growth rates for two quarters. That’s harder for me to believe at this point, so maybe I should look into betting against the intrade contract.
Maybe we’re in a Great Maturation. We’ve grown up since the economic shocks of youth. Look back far enough with an extended timeline, and the swings were wilder: the depression of the 1930s left American families leaving homes on cargo trains in search of jobs, and it took more than two decades for the stock market to recover. In the 1970s, Americans had to line up for gasoline, but we didn’t leave home. In the 2000s, we now call our brokers upset our stock funds are down 10% and yet still gas up the SUVs. As the economy has matured, Americans have grown more affluent and the Fed’s control of economy shocks has grown wiser. The real hope is our move toward a service, knowledge worker economy has made us less tied to the farmland dust bowls and oil commodity price collapses of the past.
Or, that could be wrong too, and we’re just cresting at the top of a Roman Empire bell curve.
The “Great Moderation” is highly likely to be a statistical artifact due to chronic understatement of inflation. The CPI was modified to dampen inflation in the 80′s and again in the 90′s.