The Depression´s “Great Moderation”

It´s always interesting to see that not many perceive the low growth of this ‘recovery’ as clear evidence that the economy is in a depression (not a “Great” one, but one nevertheless).

The chart provides an illustration:

Depressions´ Great Moderation_1

At the WSJ Jon Hilsenrath writes about his (and the markets´) befuddlement in Why the Economy—and the Fed—Keeps Getting Knocked Off Track:

The peril of a slow-growing economy is that even small disturbances can knock it off stride, a reality now bedeviling the U.S.

A slew of soft economic reports in recent days has led Wall Street analysts to again reduce their estimates of U.S. growth. It now looks possible U.S. output will nearly be flat for the first half of 2015, and might even contract on average over the first half. J.P. Morgan economists see a growth rate of just 0.5% for the first half.

This softness, which is likely to constrain the Federal Reserve as it eyes when to raise short-term interest rates, is befuddling many economists who just months ago pointed to signs the U.S. economy was kicking into a higher gear. Many of the economy’s underlying fundamentals still look strong: companies are hiring, and incomes and wealth are rising. Interest rates are low and supportive of growth while government fiscal policy—a drag early in the recovery—has become neutral.

A variety of indicators, though, tell a different story. The Federal Reserve on Friday reported U.S. industrial production contracted in April for the fifth straight month, down a seasonally adjusted 0.3% from the month before. A University of Michigan index of consumer sentiment also droppedSoft April retail-sales data and dismal trade numbers, both on Wednesday, had already led analysts to reduce their estimates of growth.

“Economies, like bicycles, are more stable when growing at moderate speed than when growing slowly,” said Lawrence Summers, a Harvard University economics professor and former Obama administration economics adviser, in an interview. A slow-growing economy “is one moderate sized shock away from recession.”


The U.S. economy has actually been less volatile than normal since the recession ended in mid-2009, according to James Stock, a Harvard University economics professor who coined the term “Great Moderation” to describe the steady growth rates of previous decades.

Deviations in growth from one quarter to another have been no larger in this recovery than they were in the three recoveries preceding the past recession, he said. Moreover, deviations in growth from one year to the next in this recovery have actually been half as large as they were during the three previous recoveries.

Yet he sees a risk if economic turbulence grows.

“If you are growing at a low level, you are going to be more vulnerable to those major shocks than you would be if you were growing at 3.5% or 4%,” he said. “This is a major challenge for policy.”

Because interest rates are already near zero—in part because of the slow growth rate—the Fed doesn’t have room to cut them in response to a downturn if one actually does occur.

The thing is that most talk about “Great Moderation” as something only pertaining to growth, forgetting about the associated level.

The chart below illustrates why the ongoing “Great Moderation” is consistent with a depressed economy. The chart describes in ‘phase space’ the degree to which growth ‘spreads out’ (is volatile).

Depressions´ Great Moderation_2

It is clear that real growth volatility is significantly lower during the ongoing ‘recovery’, than it was during the original “Great Moderation”. If you discard the low growth of the 2001 recession, real growth at present has been far lower than real growth in 1992 -07.

If you look at the first chart above, you see why we are in a depression. During the “Great Recession”, real output contracted and extremely low growth thereafter has not directed it back to trend.

The next chart describes in ‘phase space’ the behavior of nominal growth (NGDP or nominal spending growth). It is even more stable now than before, but note that at present, the growth rate is not much different from the nominal growth rate observed during the 2001 recession.

Depressions´ Great Moderation_3

The big question is; if the Fed has the ability (and note that for decades nominal growth was very volatile) to provide nominal growth stability (that translates into real growth stability), why can´t it also do it at a non-depressed level?

In other words, if it can keep nominal growth chugging along at a ‘constant’ rate, why can´t it temporarily increase that rate so that the economy will climb out of the ‘hole’ it´s in?

It´s certainly not because interest rates are at the ZLB. As Watson puts it, rates are near zero in part because (nominal) growth has been so low. For goodness sake, then, increase the nominal growth rate!

Unfortunately, Janet & Friends prefer to speak about “policy normalization”, meaning increasing the FF target rate. They would do much better if they switched to a target level for nominal spending.

One thought on “The Depression´s “Great Moderation”

  1. Martin Luther once nailed his theses to the front door of the prominent and inept Catholic church.

    This is one post that Marcus Nunes should nail to the front door of the US. Federal Reserve.

    Yes, the Fed wants price stability, and does not care if price stability is married to a Japan-style economy. It will have its sacred price stability.

    Egads–what about real output, jobs and prosperity? Meanwhile, Janet Yellen blabbers about women’s incomes.

    People can stop going to church or change religions (in free societies).

    How do we stop the Fed?

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