What Is the Great Moderation?
Let me explain what the Great Moderation is—it's the term for the stretch of reduced macroeconomic volatility that the United States went through starting in the 1980s. During this time, the standard deviation of quarterly real GDP dropped by half, and inflation's standard deviation fell by two-thirds, based on data cited by former Fed Chair Ben Bernanke. Essentially, you can think of it as a long period of steady low inflation paired with consistent economic growth.
Key Takeaways
The Great Moderation covers the time from the mid-1980s up to the 2007 financial crisis, when the US saw much less economic ups and downs. In his 2004 speech, Bernanke pointed to three possible reasons: shifts in the economy's structure, smarter economic policies, or just plain luck. Looking back, his positive take on it was way too early, since it all crashed into the worst recession since the Great Depression just a few years later.
Understanding the Great Moderation
Before this period, the US economy was a rollercoaster—think Vietnam War-era inflation in the 1960s, the end of Bretton Woods, the stagflation recessions of the 1970s, and wild interest rates with a double-dip recession in the early 1980s. It was rough. Then came the Great Moderation, where inflation stayed low and stable, and any recessions that hit were pretty mild by comparison. You could say it was a welcome break from the chaos.
How the Fed Portrayed the Great Moderation
The Federal Reserve often credits this stability to the monetary policies started by Paul Volcker and carried on by Alan Greenspan and Ben Bernanke. In that 2004 speech, Bernanke broke down the causes: structural changes like computers improving business decisions, financial system advances, deregulation, a move to services, and more trade openness. He also noted how better macroeconomic policies tamed those old boom-bust cycles, with economists linking it to evolving ideas on monetary and fiscal policy. And then there's the luck factor—fewer big economic shocks, not necessarily permanent fixes. But honestly, that speech comes off as too congratulatory now.
The Failure of the Great Moderation
A short time after Bernanke's talk, everything fell apart with the financial crisis and the Great Recession. Years of imbalances built up under the Fed's loose money policies finally exploded. The housing market tanked, inflation spiked in early 2008, credit froze, and we got the worst global downturn since the Depression. Here's why it happened: normal checks on monetary policy broke down during this era. Globalization, linked financial markets, and the dollar's dominance let the Fed's inflation spill overseas, hiding domestic price rises. Each recession, the Fed just printed more money to patch things up. It was like choosing to risk a big crash later to avoid small pains now—think of it as ignoring a broken leg with painkillers until it shatters completely. The so-called stable economy from the Great Moderation ended in a massive global failure.
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