It’s called the Great Moderation, and it’s roughly 20 years old, give or take. The burning question: will it get any older.
The moderation is a reference to the fall in macroeconomic risk in the U.S. since the mid-1980s. GDP volatility has fallen dramatically since the roller coaster ride of the 1970s and early 1980s. The primary catalyst: shorter, shallower recessions that occur less frequently. In short, economic nirvana. But what’s behind the fading of recession risk?
Among the various theories for why the angels of moderation have graced the U.S. economy: the Federal Reserve has learned a thing or two over the decades in how to dispense monetary policy that’s not too hot, not too cold. The rise of the services economy, which tends to be less cyclical, is a factor too.
But is the Great Moderation now living on borrowed time? It’s a timely question for a number of reasons, starting with the fact that the U.S. economy is probably already in a recession, as we’ve discussed. Will this one be short and shallow too?
Meanwhile, there’s some debate about whether the Fed’s now planting the seeds for higher inflation down the road. Consider yesterday’s comments by Dallas Fed President Richard Fisher, a voting member of the FOMC who bluntly warned that further monetary easing at this point may cause trouble later on, and so he advised against “repeating the oft-prescribed remedy of inflating our way out of our predicament with a wing-and-a-prayer promise that it can always be reined in later. It is for this reason that I have maintained a strong reluctance to further general monetary accommodation.”
The Fed meets again at the end of the month to consider interest rates anew. Meantime, it’s clear that low inflation was a crucial factor in the Great Moderation of the past generation. If inflation’s headed higher, one can imagine that the Great Moderation may become somewhat less moderate in the years ahead, as your editor detailed in the latest issue of Wealth Manager. As a preview, there are a number of clues that suggest the era of calm economic cycles may have run its course. For a closer look as to why, read on….