Great Moderation

Definition

The Great Moderation refers to the extended period of relatively low and stable inflation, along with reduced macroeconomic volatility, experienced by many advanced economies, particularly the United States, from the mid-1980s to the late 2000s.

5 Must Know Facts For Your Next Test

1. The Great Moderation was characterized by a significant decline in the volatility of output growth and inflation in the United States and other advanced economies.
2. Improved monetary policy, with central banks becoming more focused on price stability, is considered a key driver of the Great Moderation.
3. Structural changes in the economy, such as the rise of global trade and the increased use of information technology, may have also contributed to the reduced macroeconomic volatility.
4. The Great Moderation came to an end with the onset of the Global Financial Crisis in the late 2000s, which led to a resurgence of economic instability and higher inflation.
5. The experience of the Great Moderation has influenced the way central banks approach monetary policy, with a greater emphasis on inflation targeting and the management of expectations.

Review Questions

• Explain how the Great Moderation is related to the historical picture of inflation.
  • The Great Moderation is closely tied to the historical picture of inflation in advanced economies, particularly the United States. During this period, inflation was relatively low and stable, which was a significant departure from the high and volatile inflation experienced in the 1970s and early 1980s. The improved monetary policy, with central banks becoming more focused on price stability, is considered a key factor that contributed to the Great Moderation and the more favorable inflation environment.
• Analyze the potential causes of the Great Moderation and how they may have influenced macroeconomic volatility.
  • The Great Moderation was driven by a combination of factors, including improved monetary policy, structural changes in the economy, and the increased use of information technology. Central banks became more focused on price stability, which helped to anchor inflation expectations and reduce macroeconomic volatility. Structural changes, such as the rise of global trade and the increased use of information technology, may have also contributed to the reduced volatility in output growth and inflation. These factors worked together to create a more stable macroeconomic environment during the Great Moderation period.
• Evaluate the impact of the end of the Great Moderation on the historical picture of inflation and the broader macroeconomic environment.
  • The end of the Great Moderation, marked by the onset of the Global Financial Crisis in the late 2000s, had a significant impact on the historical picture of inflation and the broader macroeconomic environment. The resurgence of economic instability and higher inflation following the crisis challenged the assumptions and policies that had underpinned the Great Moderation. Central banks were forced to reevaluate their approaches to monetary policy, with a greater emphasis on managing inflation expectations and addressing the risks posed by financial imbalances. The experience of the Great Moderation and its subsequent end has shaped the ongoing debate and evolution of macroeconomic policy in advanced economies.

Related terms

Inflation: The sustained increase in the general price level of goods and services in an economy over time, resulting in a decline in the purchasing power of currency.

Macroeconomic Volatility: The degree of fluctuation in key macroeconomic indicators, such as GDP growth, unemployment, and inflation, over a given period.

Monetary Policy: The actions taken by a central bank to influence the money supply and interest rates in an economy, with the aim of achieving economic stability and growth.