Explaining Southern California's economy

Econ 474: Whatever happened to the 'Great Moderation?'

I'm introducing a recurrent weekly feature to the blog. It's called "Econ 474," and I'll leave it to the commenters to figure out why. For my part, I'll say that I want to blog about some key economics and business topics that bear on Southern California, but I'd like it to be a bit more involved that good-old Econ 101. 

Today, let's take a look at what, prior to the financial crisis. economists were calling the "Great Moderation." The current Federal Reserve Chairman, Ben Bernanke, summarized it pretty well in a 2004 speech -- before he succeeded Alan Greenspan, and obviously four years prior to the financial crisis:

One of the most striking features of the economic landscape over the past twenty years or so has been a substantial decline in macroeconomic volatility. In a recent article, Olivier Blanchard and John Simon (2001) documented that the variability of quarterly growth in real output (as measured by its standard deviation) has declined by half since the mid-1980s, while the variability of quarterly inflation has declined by about two thirds.1 Several writers on the topic have dubbed this remarkable decline in the variability of both output and inflation "the Great Moderation." Similar declines in the volatility of output and inflation occurred at about the same time in other major industrial countries, with the recent exception of Japan, a country that has faced a distinctive set of economic problems in the past decade....Reduced macroeconomic volatility has numerous benefits. Lower volatility of inflation improves market functioning, makes economic planning easier, and reduces the resources devoted to hedging inflation risks. Lower volatility of output tends to imply more stable employment and a reduction in the extent of economic uncertainty confronting households and firms. The reduction in the volatility of output is also closely associated with the fact that recessions have become less frequent and less severe.