What Do You Mean by the ‘R-Word’? A Guest Post

There’s been plenty of talk in recent weeks that a recession is coming (or that we are already in recession). Indeed, the latest reading from InTrade.com suggests that there is about a 70 percent chance of a recession – defined as two consecutive quarters of negative economic growth – in 2008.

It is an interesting story, but today’s pessimism does not sit easily with the general optimism of macroeconomists over the past decade or so (a point made by David Leonhardt in the Times). Researchers have dubbed the period since the mid-1980’s “The Great Moderation,” arguing that while the business cycle may not have been beaten, it has certainly lost its bite. Careful studies of this transformation suggest that the ups and downs of the business cycle have been dramatically dampened since around 1984. Since then, nearly all measures of economic activity have become less volatile. The forces behind this moderation remain something of a puzzle, but they extend beyond monetary policy, and hence, this is not just a Greenspan effect.

The graph below shows that the amplitude of the business cycle roughly halved since the mid-1980’s. And yet the commonly-used yardstick of a recession (two quarters of negative economic growth) remains unchanged. This observation should give some optimism that even the confluence of several factors slowing the economy may not trigger a recession.

Recession graph

So this brings me to my question: are those who are using the R-word suggesting that the “Great Moderation” is over, or simply that we are facing an especially unusual set of adverse business conditions? Or was there never any real change in the structure of the economy, and the last couple of decades have been simply a statistical fluke?

My guess is that different answers to these questions can explain why some forecasters have divergent forecasts. But I have been surprised by the failure to speak directly to these questions, as the long-run implications of the competing explanations are important and very, very different.


The "Great Moderation" is highly likely to be a statistical artifact due to chronic understatement of inflation. The CPI was modified to dampen inflation in the 80's and again in the 90's.

Betting Short on Recession

I'm betting against recession on my Intrade account. I don't think we're going to see a recession. The problem is that the moderated economy of the past 25 years has lowered our threshold for pain. So growth slows, or we even have a month or two of negative growth. That sucks, but not as bad as the downturns of the previous 300 years of the American economy (before the moderation). The media (and therefore the public & the politicians) are making this out to be worse than it really is.


Just about every system has a threshold, or peak capacity on this planet, be it in terms of resources and population, population and space, size or any number of factors that we measure as a characteristic or product of that system. Could the Moderation simply be a result of separate dynamic economic systems (the nation state) merging into the global system? Or could it be that given the natural resources at our disposal, labor and infrastructure that the global US economy is peaking or nearing a naturalized systematic threshold of growth? Perhaps. Perhaps uninterrupted growth is a realized dream, I'm not that smart and I don't have enough historical examples to point to a threshold for our current situation- as we in the United States have far surpassed Cyrus' Persian Empire, Caesar's Roman Empire or Victoria's British Empire.

But there are real physical limits to how many people we can support with current economic systems and the depletion of natural resources (like arable land) despite improvements in technology that continue to increase gains. But even a steroid doped baseball player can only hit so many homeruns. As a maxim, there are limits to just about everything... including matter in the universe.


Data Miner

Is it possible that we were mis-estimating GDP during the high inflation years from late 60s to the early 80s? High inflation may lead to a larger error variance in the measurement of both nominal and real GNP. Hence wilder swings in measured "real" GNP. Thus, part of the great moderation is also lower inflation and possibly even underestimation of real GNP growth in the 90s (cf. R. Gordon or Baumol on quality adjustments in a period of real technical change).

Not saying that there isn't something going on, but an adjusted measure might show a more gradual shift from the 70s to the late 80s and 90s.

Lyn LeJeune

I read this post three times. Then I called my husband over and he read it once. My sister came over and she read it twice and then so did my mother. We all had the same questions: If we all make about 75,000 a year - not combined - at least not yet! what does all this mean to us. More to spend or less to spend? Will we be colder in the winter and hotter in the summer? Can we go to see Uncle Charlie in Florida by car? Will Briana have crooked teeth the rest of her life? Should we start buying Pete the dog that cheap dried food? Should we wait to make out our yearly charity checks? And, when will be get our rebate checks?

Lyn LeJeune - The Beatitudes Network-Rebuilding the Public Libraries of New Orleans and "All May Not Be Well; And All May Not Be Well; And All Manner of Things May Not Be Well," at www.beatitudesinneworleans.blogspot.com

Richard Holwill

If we are amid a Great Moderation, I suspect that it is largely because Congress didn't get too excited about the little ups and downs that we've seen over the past 30-odd years. Now, with Congress intent on passing an economic package to stimulate the economy, I suspect that the moderation will end, first with inflation and then with a recession worthy of the name. I, for one, am praying for gridlock.

scott cunningham

I was not aware that the intrade contracts were actually based on two consecutive quarters of negative economic growth until recently when I read the fine print, but when I learned that, I had a harder time believing those estimates. I've been reading more about a slowdown, possibly positive growth but still low, and hadn't really seen as much of people forecasting negative growth rates for two quarters. That's harder for me to believe at this point, so maybe I should look into betting against the intrade contract.

Ben Kunz

Maybe we're in a Great Maturation. We've grown up since the economic shocks of youth. Look back far enough with an extended timeline, and the swings were wilder: the depression of the 1930s left American families leaving homes on cargo trains in search of jobs, and it took more than two decades for the stock market to recover. In the 1970s, Americans had to line up for gasoline, but we didn't leave home. In the 2000s, we now call our brokers upset our stock funds are down 10% and yet still gas up the SUVs. As the economy has matured, Americans have grown more affluent and the Fed's control of economy shocks has grown wiser. The real hope is our move toward a service, knowledge worker economy has made us less tied to the farmland dust bowls and oil commodity price collapses of the past.

Or, that could be wrong too, and we're just cresting at the top of a Roman Empire bell curve.


So what does the Intrade number really mean? That a handful of people read the news predicting recession and decided to believe it? Intrade seems to be heavily influenced by people reacting to news events (remember the Obama/Clinton rise/fall after Iowa and N.H.).

I doubt that many Intraders have any special insight into matters they are betting on.

Manzell B

I suspect that with the 'advent' of the internet and electronic banking schemes, what we are actually seeing as that marginal competitive advantages that one firm holds over another are:

1 - Shorter duration. The time it takes to successfully co-opt, adapt to, or counter business competition is much faster.

2 - More complete information: Customer information is out there for anyone who wants it. Pricing information for competitor products/servces for nearly any arbitrary market in the country is out there. The data is there as well as the means to transmit it cheaply to firms.


Ha ha ha. I lived in Connecticut during the 1990-1992 recession - known as the "Great Recession" in the region - and it sure was news to everyone that the business cycle had moderated. It was a horrible, horrible time, one that I'll never forget. It's doubtful I'm alone in that respect.


If we do go into a recession, the good news is that it is likely to be short. Between 1900 and 1975, we had recessions every few years -- and they lasted a long time, some of them for years. During the last 30 years, we have only spent around 3 years in recession. The truth is that we have had it good, and we are now a bit sissified. If recession comes, let's hope it follows the trend of the last few decades and doesn't last that long.


Well it's obvious we have video games now.
There were none before that the mid '80s

The mid-'80s is when all the cartridge
games came out...and it's been moderation
since then.

Betting Short on Recession



The "Great Moderation" may be an artifact of the housing bubble. In 1983 for example, the house I was selling had a real estate appraisal that was down from 1982, in part because 12 out of 13 of the comparables were foreclosures.

The danger that we will have a super Mimsky moment when all asset classes are deflated is suggested by the size of the derivative market
that must be eventually settled or "unwound".

According to a wikipedia entry, derivatives.
According to the Bank for International Settlements, the total outstanding notional amount is USD 516 trillion (as of June 2007).

Compared to 22 trillion in US mortgages.


Markets are all about communication, whether it be in spoken or written language or in currency. (I know there is more to it, but work with me..)
A friend tells me that one transaction involving gasoline used to last up to two months from the time the truck backed up to the pump until the time payment was received. This was just a few years ago. Now the whole transaction takes less than one day.

The current economy is much more efficient, although more volatile in some respects. Factories are less likely to produce type 1 widgets for six months whether they are needed or not. There are other examples... "Just in time" inventory. FedEx. Money, goods, and information flow more easily now.

I would hesitate to say that a recession "can't happen". More likely one industry tanks while another one ascends. There still could be an awful confluence of bad karma...


The personal savings rate has been steadily falling since the 70's, so it's possible that the moderation was due to people being able to continue to spend money out of savings during recessions. Now with a negative savings rate, this is no longer possible in the long run.

Also, immigration rates have been speeding up since the 70's, so a larger market has been available to drive growth. If immigration is restricted, this buffer would not exist anymore.

Craig Sillitoe

Before the mid-eighties professional
forecasters, including the Federal Reserve Board were reasonably able to outperforme the GDP forecast made by a random model. But thats no longer true as these events have a higher degree of randomness. This may point to a parallel between the changed pattern of GDP growth and a phenomenon of systematic day trading, which has a known cause.

Systematic day traders look for rare but reliable non-random events in the markets. Most short term market movement is random, but when a successful traders' 'setup' occurs, they have a better than random probability of predicting the outcome. Setups are kept secret because the nature of the market means that the more people that are trading a given setup, the less reliable it will be, and therefore the greater degree of randomness regarding that setup.

Here's example of how that works. If a successful setup says buy whenever the market falls by 10 and sell soon after, and I post this setup on a discussion forum and many traders use it. While we are all trying to buy at a discount of 10 some will miss out as the price bounces up to the reliable profit level. Not wanting to miss out next time, some traders jump in early at a discount of 8. They make less profit and force some traders wanting deeper discounts to miss the trade.

These actions create both greater randomness and lower volatility. In the case of the markets the actions are caused by greater level of competition for non-random events. In the case of the economy the cause may be competition, or a greater level of some other controls acting more frequently on non-random events.



You said: "I have been surprised by the failure to speak directly to these questions" [Great Modertion, fact or statistical fiction], "as the long-run implications of the competing explanations are important and very, very different."

That's the article I'd like to see written next...


I believe that the great moderation is not over, but that it is almost complete. I think if we incorporate the effects of increased globalization and all its implications (increased specialization and diversification between and within countries), we witness convergence. Recently, this convergence has been hampered by the inadequate allocation of capital. I posit that in retrospect, we should have regulated bank loans more vigorously. I believe it is because too many assets were allocated toward the mortgage industry, that we saw so much inflation and the eventual bursting of the housing bubble.
This is not too much unlike the great depression in some respects. Granted, we have a Fed Chairman who has done the research and knows how to stave off such a horrible event, we again have witnessed the importance of industry regulation (which i believe in only to the extent that it does not hamper free trade severely). That said, were improper loans not made, more capital could have been allocated toward developing nations, such as those in Latin America for instance. Such investments, i believe, would have been much wiser and more profitable, when we have yet to measure a proper risk premium for "bubbles," not to mention how we have trouble determining when a bubble is in effect.

We are in a recession, and it is awkward in that the Keynesian multiplier may not help us when the American people want to save money. It seems that Government expenditure may have to increase to keep prices from falling, because deflation is devastating. Nowhere is government intervention more important, on the basis of time and scale, than in the housing sector.

Furthermore, I believe that Capital Markets should allocate a boatload of money to developing nations. This can be done in tandem with efforts to make American exports cheaper, so that they may be more appealing abroad and prop up world markets.

Above all, and thankfully Ben Bernanke knows this, we must maintain international credit and liquidity levels.

On an interesting side note, I think the Internet is about to become much more important than it already is. I think it will develop in prominence with the development of the fourth market. The internet can prevent damaging "fire sales," where people and businesses alike need liquidity quick. Invest in craigslist.com