The “Great Moderation”=the “Great Stagnation”? Not according to ‘phase diagrams’

In the last few days New Arthurian (NA) critiqued a few of my posts. I sent him an e-mail which he published. Jazz Bumpa at Angry Bear has made fresh critical comments. Here I´ll concentrate on the two Part JzB post.

In Part I Jazz Bumpa looks at real growth and concludes:

The point of all this is to demonstrate that there is more of a difference between the pre- and post 1982 periods than simply a volatility reduction.  There is also a decline in RGDP growth, if you dig into the numbers to find it.  The Great Moderation really was the Great StagnationAnd it culminated in the Great Recession.

In Part II he looks at volatility and ends:

As I said, I think the Great Moderation is a myth.  It’s entire existence is predicated on 2 things: 1) a brief ultra-high volatility blip due to a double dip recession; and 2) completely ignoring the existence of the first little moderation.

But what’s happened since is truly remarkable.  We now have what some people consider to be [and applaud as] remarkably stable GDP growth.  But what we actually have is the lowest non-recessionary GDP growth ever recorded, coupled with historically high RSD.  This is a truly ugly economic environment.  Anyone graduating now is the unluckiest of all.

In my view he complicates things. RSD in his last sentence stands for “Relative Standard Deviation”. In statistics lingo that´s the “Coefficient of Variation” (the ratio of the standard deviation to the sample mean – the inverse of the signal/noise ratio). Splicing periods to conform to presidential administrations is not very useful (for example, measures/policies of one administration can have most of their effects on the subsequent one). To top it up I think his charts are very hard to read. For example, this one on RGDP growth and Volatility:


Graph 1 is a scatter plot of Standard Deviation [St Dev] vs RGDP growth over an 8 year period.  The X-axis value is the average RGDP over the previous 8 years [32 quarters] while the Y-axis value is the standard deviation of RGDP growth over the identical period.  There’s nothing magical about using an 8 year period, you get a similar picture using a 15 year period.

I don´t really understand his choice of periods. Why 8 ears? JzB gives a reason:

When I looked at the 15 year graph I noticed something that made me want to use an 8 year period, and that is the data trend over presidential terms.

Choosing ‘epochs’ to subdivide a (long) period of time is always somewhat arbitrary. I chose ‘epochs’ that are ‘popular’. There´s the “Golden Age” (from the mid-1950s to late 1960s); the “Great Inflation” that extends from the late 1960s to the early 1980s, the “Volcker Disinflation” (I prefer “Volcker Transition”) that goes from the early 1980s to 1986, the “Great Moderation”, from 1987 to 2007, and the “Great Recession”, in which we still live.

And I chose to show both real growth and its volatility on single chart, akin to a ‘phase diagram’. Each point in such a diagram relates real growth in quarter (t-1) to real growth in quarter (t). Such a diagram is visually appealing because you quickly get an idea of the degree of dispersion (volatility) of growth. The chart below shows this for the four ‘epochs’ defined. The circle (of same size and position in all the panels) shows that during the “Great Moderation” real growth was pretty stable, with most of the points contained inside the circle. That´s clearly not true for the other ‘epochs’.


During both the “Golden Age” and the “Great Inflation”, for example, growth is very volatile (spread out over the space). In the first case there´s a predominance of ‘high’ rates, while in the second case ‘low’ rates predominate. More popularly, during the “Golden Age”, ‘booms’ are frequent while during the “Great Inflation” ‘busts’ lead. Note that the “Great Recession” is all ‘bust’!

What´s behind that configuration of different economic ‘states’? Since real growth is the outcome of nominal growth and inflation, it is natural to investigate nominal stability. And since it is the Fed that imparts nominal stability I chose to divide the periods according to the different Fed Chairmen. Interestingly (but not surprisingly) the degree of nominal stability/instability (low/high volatility) matches up well with periods of low/high real growth volatility. In the chart I call Nominal GDP growth the “Genie”. The Fed can either keep it ‘locked’ inside the ‘bottle’ or let it ‘escape’ either to the ‘northeast’, which defines an area of rising nominal spending growth (usually accompanied by rising inflation) or, as it did more recently, in the ‘southwest’ direction, which is associated with falling nominal spending growth (usually accompanied by falling inflation).


One conclusion: To equate the “Great Moderation” to a “Great Stagnation” is quite inappropriate (to say the least). And to imply it was behind the “Great Recession” is to forget the role of the central bank in maintaining nominal stability.

My punch line: The obsession of policymakers in the 1960s with unemployment led to the “Great Inflation”. Bernanke´s obsession with inflation paved the way to the “Great Recession”.

There´s only one ‘productive obsession’ to wit, the sole focus of the Fed on providing nominal stability and preferably in the guise of a stable level path for NGDP.

9 thoughts on “The “Great Moderation”=the “Great Stagnation”? Not according to ‘phase diagrams’

  1. Pingback: The “Great Moderation” = the “Great Stagnation”? The Corner

  2. Marcus –

    Thank you for your long and thoughtful response.

    Yes any epoch division is arbitrary. I first arbitrarily went with 15 years as a way of smoothing short term variation. The data arranged itself by presidential administration, and the trek across time suggests a narrative. Policy matters – and it’s more than just Fed policy.

    In your phase diagrams, the golden age has many more dots to the upper right than to the lower left, indicating higher overall RGDP growth over the epoch. The great inflation epoch has those as well, plus more lower left dots resulting from recessions in 1970, 74, 80 and 82. The big GDP decline of a recession is the major cause of GDP volatility; next is the rise in a sharp recovery, if you’re lucky enough to get one.

    The great moderation has a smattering of dots to the lower left, and NONE to the upper right. We didn’t totally eliminated the dips, but the dramatic tops became nonexistent. Yes, volatility is lower. So is average growth, due to the elimination of those higher numbers.

    I find your exposition to be wholly consistent with my narrative. In the 60’s, we had high RGDP growth, and declining volatility. In the 70’s volatility increased a bit, while RDP declined dramatically. In the 80’s GDP recovered somewhat, at the cost of high volatility. The 90s brought volatility down, and raised GDP a bit. That is the great moderation in a nutshell, and it resulted form a recession free decade. This century has been dismal.

    Put a trend boundary across the tops here, and it’s a slow road to perdition.

    I consider the current 13-year slide into low and declining RGDP growth to be an unacceptable price to pay for only an intermediate level of absolute volatility. Plus, note that RSD is at the 1982 level.

    It’s one thing to say, “I disagree,” and quite another to say, “you’re wrong.” Clearly, we see the world through starkly different prisms. For one thing, I don’t share your faith in the absolute power of the Fed, for another, I believe that fiscal policy can be a powerful tool, if it’s taken off the shelf and put to work.

    At any rate, this is a stimulating discussion, and you got me to dig into data, which is always good. BTW – I don’t mind being proven wrong, but doing so requires actually proving me wrong.

    Best regards,

    • JzB
      The “wrong” is to be translated as “not so fast”. A problem with not being a native speaker! You said:
      “I find your exposition to be wholly consistent with my narrative. In the 60′s, we had high RGDP growth, and declining volatility. In the 70′s volatility increased a bit, while RDP declined dramatically. In the 80′s GDP recovered somewhat, at the cost of high volatility. The 90s brought volatility down, and raised GDP a bit. That is the great moderation in a nutshell, and it resulted form a recession free decade. This century has been dismal.”
      1. Volatility did not decline in the 60s. It was just as high as in the 70s.
      2. Why was it a recession-free decade? My claim is that monetary policy finally found its ‘vocation’.
      3. I think you put much weight on the stabilizing properties of fiscal policy. The ‘vocation’ of fiscal policy should be to provide the highest possible trend level. Let monetary policy work to keep the economy ‘hugged’ as closely as possible to that trend level.
      PS some time ago I compared and contrasted the 60s and the 90s:

  3. Marcus –

    No offense taken. Re your points:
    1) Just look at values for the decades. Sixties lower St Dev than 50’s or 70’s with higher RGDP.

    Time Avg St Dev RSD
    55 – 60 3.4 3.44 1.03
    61 – 70 4.3 2.34 0.54
    71 – 80 3.2 2.79 0.87
    81 – 90 3.4 2.46 0.73
    91 – 00 3.5 1.47 0.42
    01 – 10 1.7 2.08 1.25

    2) Could be. Then again, maybe the ramp up in federal spending was playing a part.

    This illustrates why I like using a moving data kernel. It smooths short-term variations, and mitigates the arbitrariness of kernel size. A larger kernel is smoother, and the peaks/valleys are delayed, but the general shape remains similar.

    3) Which is the first mention I’ve made of fiscal policy in this discussion. I think it’s most potent, and appropriate at or near the ZIRB, and now that we’re there, we refuse to even consider it.

    BTW, my graph that you posted might be hard to read. But my narrative was intended to make it all clear. This one, though, is very easy to read, and tells the story quite dramatically.

    The two little moderations are obvious, as is the sharp peak at ’82. Our current condition is very disturbing.

    Since we’re conversing, I’ve been meaning to ask something. IIRC both you and David Beckworth have stated that the current Fed is inept. With interest rates near zero and unusual open market operations in place, what other policy tool do they have that could energize the economy?


    • JzB,
      Since we discussed NGDP volatility at Angry Bear this summer I feel I should throw in my two cents.

      1) You and Marcus are partially talking past each other.

      This is particularly true when you are talking about recession free decades. Marcus is referring to the 1990s and you are talking about the 1960s. Yes Federal expenditures ramped up in the 1960s, but as a percent of GDP they fell sharply in the 1990s:

      Furthermore, to be clear, you are talking about RGDP volatility and Marcus is talking about NGDP volatility. Does this matter? Kind of, because it relates to why this discussion is so important.

      I graphed the NGDP and RGDP trailing 2-year average standard deviations and noticed a very strong correlation and almost no difference since 1954. The most notable exceptions are 1975-77 and 1981-83. Since these are 2-year trailing averages it’s easy to see both of these exceptions are mostly due to the energy price shocks (although the first period also marked the end of Nixon’s wage and price controls).

      Thus, with few exceptions, output volatility is due to shifts in aggregate demand (AD), not aggregate supply (AS). Thus if policymakers control NGDP, reducing NGDP volatility should be very desirable.

      2) Relative standard deviation (RSD) is the wrong measure.

      To see why, consider two countries with very different rates of potential RGDP growth. Let’s suppose one grows at an average annual rate of 2% and the other grows at an average annual rate of 4%. Suppose the RSD is 0.5 for both countries. Furthermore, let’s assume each country’s economy is performing at potential GDP.

      Then a 1-standard deviation loss in output would result in a 1% decline in RGDP in the slow growing country and a 2% decline in output in the fast growing country. The output gap would be larger in the faster growing country, and assuming equal Okun’s Law constants, the unemployment gap would also be larger.

      So what matters is not RSD but the absolute standard deviation.

      3) Both NGDP and RGDP volatility have been incredibly low this recovery.

      NGDP and RGDP standard deviation have averaged 1.76 and 1.58 respectively since 2009Q3. This compares with 2.17 and 2.11 respectively during the Great Moderation (1987-2005). This is the case despite going over several Federal, state and local fiscal policy cliffs since late 2010. To me, this is very strong evidence that the liquidity trap is a myth. And if so, the only thing restraining this recovery is monetary policy that is inadequately expansionary.

      In my opinion, arguments to the contrary are merely allowing policymakers to be free of responsibility, and enabling them to continue to slow pace of this recovery under the guise of an illusory inability to do anything about it.

  4. It may be that economic growth in the entire Western world was somewhat muted from 1980 forward, due to central banks that gravitated towards independence and putting inflation-fighting at the fore. I think, in broad brush strokes, this is what Jazz Bumpa is getting at. Indeed, we have seen sovereign debt yields tumble for 30 years in a row.

    The sad thing is 1. That inflation battle has been won, but the central banks are ossified into inflation-fighting mode, and 2. better results would have been had by going to a NGDP-targeting regime, with a little less squeamishness about some inflation.

    But overall, the Great Moderation was a pretty good period, though Jazz Bumpa does rekindle my fondness for the 1960s. BTW, real per capital incomes grew by 30 percent in the 1960s in the USA, and the PCE deflator closed out 1969 at 4.5 percent.

    Marcus Nunes understanding of postwar Fed policies is unrivaled, in my opinion.

  5. Sorry I took so long to get back. Life, etc.

    Marcus – I’ll check that link. Thanks.

    Mark –
    1) I don’t think Marcus and I are talking past each other. We were both talking about RGDP. In fact, this discussion started when Marcus chose that metric.

    I certainly agree that demand shocks dominate,

    2) Of course the same RSD relates to different absolute variances with different growth rates. I’m failing to see your point. My point is that RGDP growth has been in a secular decline since the mid 60’s, and Absolute St Dev since the late 50’s. The great moderation was just a continuation of these trends after counter-trend moves through the 70’s and 80’s.

    3) Look at 13 Q Absolute St Dev of RGDP over history. Since Q2 ’10 it’s at .663. 13 Q St Dev averaged .64 from 10/1/87 through 4Q2 ’90, . It was scarcely above that level for 4 years, averaging .81 from ’95 through ’98, and a mere .41 through ’99 and 2000, then again at only .76 from Q2 ’06 through Q2 ’08. And, of course, until this century, those were in the context of much higher growth levels. We have never again reached the 8 year average growth level peak of 4.168% in Q2 1973.

    High volatility numbers are at least 1.7, so the difference between .66 and .81 is trivial. Current volatility is low, but not NOT incredibly, or even historically low. RSD, on the other hand, is historically high, and climbing.

    Current low absolute volatility is in the context of the lowest non-recessionary growth rates of the post WW II period.

    I’d like to see a thorough explanation of how you get from that to the liquidity trap is a myth.


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