A glutton for punishment, I’ve decided the Zombie Economics book manuscript I submitted a month ago (mostly online here) is in urgent need of more zombies. I’ve been struck, even in that short space of time by the extent to which, with undeniable “green shoots” now appearing, the zombie ideas I’ve written about are clawing their way through the softening soil and walking among us again. The most amazing example is that of the Great Moderation – surely you would think no one could believe in this anymore, but they do.
So, I’m planning to add a bit to each chapter, pointing to examples of these ideas being revived. I’d appreciate good examples for the rest: Trickle Down, Micro-based Macro the Efficient Markets Hypothesis and Privatisation (of course, the Queensland government gives an example v close to home).
With unemployment still above 10 per cent in the US, budget deficits in the trillions, and bankruptcy and foreclosure taking place on a massive scale, you might think that the idea of the Great Moderation would be, not just dead, but buried once and for all. You would be wrong.
This zombie idea was never really killed and it is already climbing out of the grave. In a blog post entitled ‘Does the Great Recession really mean the end of the Great Moderation?’ Coibion and Gorodnichnenko answer this question with a resounding ‘No’ present a series of graphs on the variability of real GDP growth to support the conclusion that ‘we are experiencing a particularly severe business cycle that nonetheless pales in comparison to the volatility experienced in the 1970s.’?Such a claim looks convincing if you look only at the absolute variability of GDP. But that variability reflects the combined impact of a massive fiscal stimulus from the public sector
Not only have the components of GDP fluctuated wildly, but so have all sorts of other macroeconomic variables. Brad DeLong points out that the variance of the employment/population ratio has shown the biggest spike since at least the Korean War.
More fundamentally, the idea that we are still in a ‘Great Moderation’ in which stability is the result of good policy fails the laugh test. The story used to be that the ‘good public policy’ that gave us stability consisted of the judicious adjustment of interest rates in line with a Taylor rule based on inflation rates and output growth. The response to the Global Financial Crisis started out that way, but the policymakers rapidly threw the rulebook out the window. Interest rates were cut all the way to zero. Then huge amounts of liquidity were pumped into banks and Wall Street firms through ‘quantitative easing’ and opening of the discount window. Then there was the trillion dollar bailout of late 2008, and the massive fiscal stimulus package of 2009.
Many words could be used to describe these responses, but ‘judicious’ and ‘moderate’ would not be among them. It could plausibly said that, massive as they were, the responses were still inadequate. But that just goes to point up the magnitude of the crisis.
Why then would anyone make such a claim? The answer can be sought in the internal dynamics of the economics profession. The Great Moderation vanished in 2008 and 2009, but the academic industry built to analyze it did not. Research projects based on explaining, measuring and projecting the Great Moderation, were not abandoned, and the careers based on those projects could not be diverted quickly into other ends.
Coibion and Gorodnichnenko are proponents of the view that the Great Moderation was the product of good public policy. They are the authors of a forthcoming paper in the American Economic Review making precisely this case. The paper is theoretically elegant and uses some impressive econometrics, reflecting the years of work that go into the production of such a piece (the article is based on a 2008 working paper and uses data from 1969 to 2002. But, if the Great Moderation is indeed over, such a paper becomes an exercise in economic history, and the ‘good policy’ explanation is clearly false.
Unsurprisingly, then, Coibion and Gorodnichnenko are attracted to the opposite view. A crisis that had destroyed whole national economies, bankrupted economies, doubled the US unemployment rate and threatened to bring down the entire financial system becomes, in their telling of the story, a ‘transitory volatility blip in 2009’.
We will be hearing a lot more of this kind of thing in the future. But, if we are to avoid repeating the mistakes of the last couple of decades, we must first recognise them for what they are. The Great Moderation is a dead idea, and it should be buried once and for all.