'On the Greatness of the Great Moderation'

Is the Great Moderation over?:

On the greatness of the great moderation, by Lola Gadea, Ana Gomez-Loscos, and Gabriel Pérez-Quirós, Vox EU: The period of unusually stable macroeconomic activity experienced in the US that began in the mid-eighties is known as the Great Moderation. Kim and Nelson (1999) and McConnell and Perez-Quiros (2000) were the first to document the substantial decline in US output volatility in 1984, but the academic and non-academic literature on the Great Moderation is prolific, and its possible causes – namely, changes in the structure of production, improved policy and good luck – continue to be a matter of lively debate.

Although the Great Moderation is one of the most widely documented stylized facts of modern macroeconomy, two issues could question its greatness:

• First, the Great Moderation has never before been studied in a long historical perspective as previous studies only use post-World War II data;

Can the Great Moderation be identified when considering a longer dataset? In a recent study (Gadea et al. 2015), we investigate this question. We conclude that, considering a dataset beginning in 1875, we chronologically find three structural breaks in variance that roughly correspond to the end of each of the world wars and the beginning of the Great Moderation. Indeed, the Great Moderation had as great an impact on the characteristics of the series as World War II had.  

Second, one natural question that has arisen in recent years is the possible end of the Great Moderation due to the Great Recession, which was of unprecedented severity and duration in the postwar US business cycle and led many economists to suspect a major breakdown in the GDP series. But, might output volatility not remain subdued despite the tumult created by the Great Recession? In a recent paper (Gadea et al. 2014), we formally address this question. ...

Conclusion

The Great Moderation is not over in spite of the Great Recession even if we use a historical dataset beginning in the 19th century. The Great Moderation was originally associated with a decrease in output volatility and was considered a great achievement in terms of reducing risk and of decreasing the frequency and depth of recessions. However, after carefully analyzing the characteristics of the Great Moderation, they seem to be more clearly associated with the shape of expansions. Perhaps the benefits associated with an apparent increase in stability are paid for at a very high price. Feeble expansions may be the price to pay for low volatility.