Policy Hubris, the Great Moderation, and the Roots of the Current Unpleasantness
by Virginia Postrel • Mar 31, 2009 at 9:05 am
My latest Atlantic column considers how the Fed's misunderstanding of the "Great Moderation" may have fed asset bubbles, leading to what Professor Postrel calls the Current Unpleasantness. An excerpt:
But containing inflation and eliminating, or noticeably dampening, economic downturns are two entirely different things. Congratulating policy makers for "the virtual disappearance of the business cycle" oversteps the evidence and encourages the hubris that fostered the current crisis and could make recovery more difficult. The conventional explanation for the Great Moderation gives too much credit to easily identifiable economic policy makers—"I feel the contribution of good policy cannot be overstated," said Romer—and too little to all those anonymous managers and workers whose everyday actions get summarized in the aggregate statistics that Fed economists watch so closely.
Research published in journals like the American Economic Review, dating back to a 2000 article by Margaret McConnell of the New York Fed and Gabriel Perez-Quiros of the European Central Bank, tells a different story. This line of research says that good Fed policy was necessary but not sufficient, that the business cycle never disappeared, and that most of the Great Moderation emerged not from deliberate government policy but from changes in business practices that occurred for competitive reasons having nothing to do with macroeconomic goals.
It's a fairly complex piece, so please read the whole thing.