The Great Moderation Theory: Why We Are Experiencing New Levels of Stability in Global Industrialized Markets?

Usually when an idea is preceded by the word "great" you know you are in for something big; this case is no different, at least in the mind's of academics.

Since first emerging in academic papers in 1999, The Great Moderation Theory has been gaining evidence and supports alike. The theory holds that the average level of volatility in most measures of a country's economic performance has become significantly less volatile in the last 20 to 25 years. It's not just the United States that is experiencing this shift, most industrialized nations are observing similar stabilizing effects.

Why such a sudden change starting in the 1980's? There are three large factors that academics point to; the first being improved monetary policy and its' control over inflation: Dr. Edmond Seifried in his article entitled:

The Great Moderation Theory Steps Center Stage into the Economic Spotlight, explains how these two ideas fit together:

"The first theory gives the credit to improved monetary policy. Proponents of this explanation contend that former Fed Chairman Paul Volcker provided the kickoff for the Great Moderation when he changed how the Fed created policy in November 1981. Rather than trying to fine-tune interest rates, Volcker led the Fed into an era in which broad inflation targets were created in order to stabilize inflation. Former Fed Chairman Alan Greenspan and Bernanke continued that approach with even greater fervor."
Regardless of your view of Bernanke or the Federal Reserve, their shift to control inflation has played a big role.

A second factor is thought to be the fundamental change in the way businesses control inventory. Gone are the days of massive warehouses full of products hoping to sell, today's just-in-time business inventory strategy reduces in-process inventory and only produces goods after a series of sell signals have been satisfied; Selling more and storing less.

Good fortune is also considered by academics to be a factor. Large unexpected shocks or changes to market conditions have been hitting industrialized nations less and less frequently and their impact although in isolation may be substantial, when viewed at the macroeconomic level appear quite minor.

An additional factor that I believe plays a role is the advent of the internet and high speed communications. The simple fact that we now know more about what is happening everywhere, and at anytime, may be a big contributor to the absence of large economic swings. We now have many more multiples of real-time data guiding us to make better and more informed decisions.

As our knowledge of economic forces continues to grow, and as the rate at which we can gather data and disseminate informed decisions based on that data continue to increase, I think you will see the Great Moderation become even Greater.