Look: I am eager to learn stuff I don't know--which requires actively courting and posting smart disagreement.

But as you will understand, I don't like to post things that mischaracterize and are aimed to mislead.

-- Brad Delong

Copyright Notice

Everything that appears on this blog is the copyrighted property of somebody. Often, but not always, that somebody is me. For things that are not mine, I either have obtained permission, or claim fair use. Feel free to quote me, but attribute, please. My photos and poetry are dear to my heart, and may not be used without permission. Ditto, my other intellectual property, such as charts and graphs. I'm probably willing to share. Let's talk. Violators will be damned for all eternity to the circle of hell populated by Rosanne Barr, Mrs Miller [look her up], and trombonists who are unable play in tune. You cannot possibly imagine the agony. If you have a question, email me: jazzbumpa@gmail.com. I'll answer when I feel like it. Cheers!

Sunday, June 5, 2011

What Was The Great Moderation?

The basic idea of The Great Moderation is that the standard deviation of GDP growth was much less during the recently ended moderation period - roughly mid 80's until the onset of The Great Recession than it was during the previous golden age.

This idea is not totally without merit, but let's give it a hypercritical look.  Here is the graph (first presented here) of Standard Deviation of GDP change, based on a 34 quarter data packet.

Here is the 34 period line again (blue), shown this time with Relative Std Dev (red), determined by dividing the St Dev value by the average of the same 34 data points used to calculate Std Dev.  In the chart it's been multiplied by 3.5 to put it on the same scale as the basic Std Dev line.

Each set also has a best fit straight line added.  Sure enough, they both slope down.  The Relative St Dev (RSD) has somewhat lesser slope, but this pretty much blows my theory that the Great Mod was a data artifact of declining GDP growth, though that still appears to be a minor component.

On the other hand it validates my idea that there were two little moderations during the late 60's and the entire 90's.  The 3Q '69 minimum in RSD  is well below the average value of the Great Mod, and the average of the '66 to '73 period (2.93 on this scale) is only marginally above the average of 1990 through 2007 (2.46.)  There was even a mini-moderation during the Carter presidency, prior to the huge spike in Q2 '82.  The remainder of the Reagan administration maintained an RSD value almost as high as that of the Great Recession.

Though I've couched this in terms of presidential administrations, I'm not prepared to say that there is a cause and effect due to policy.  I will say that extended recession-free periods lead to lower RSD.  The three peaks follow major recession by a year or two.  Not every recession causes a spike, but the '69 and '74 recessions did run up the RSD value, though the '90 recession did not.

I think this does validate my notion that the volatility of the golden age totally resulted from two phenomena - the post WW II readjustment to a peace-time economy, and the Stagflation of the 70's.  Rather than something remarkable, the Great Mod might just be a return to relative normality.

Does this seem sensible? Help me out, here.


Stagflationary Mark said...

My analogy would be the case of the overprotective mother.

Her goal is to protect her child from getting hurt. Unfortunately, there are unintended consequences to her actions.

The child will increasingly take on risks knowing that there are never any bad consequences.

Seeing the risk taking, the mother will increasingly place safety nets around the child.

Eventually, the child is taking enormous risks and the mother becomes overwhelmed.

What would have once just been a simple knee scrape turns into a broken neck.

Just a theory.

Of course, it doesn't help the child if the mother turns certifiably insane and rips down the safety nets that she once put in place.

Glass–Steagall Act

The first Glass-Steagall Act of 1932 was enacted in an effort to stop deflation...

The bill that ultimately repealed the Act was introduced in the Senate by Phil Gramm (Republican of Texas) and in the House of Representatives by Jim Leach (R-Iowa) in 1999.

The repeal enabled commercial lenders such as Citigroup, which was in 1999 the largest U.S. bank by assets, to underwrite and trade instruments such as mortgage-backed securities and collateralized debt obligations and establish so-called structured investment vehicles, or SIVs, that bought those securities.

I owned Citigroup and profited off of this repeal. I sold in 2004 when I turned bearish. It has since lost roughly 90% of its value.

Jazzbumpa said...

Mark -

I'm not getting your protective mother analogy. Maybe I need to digest it. I do think lack of regulation is a big contributor to the decline by 1) leading to misallocation of resources, and 2) contributing to wealth disparity.


Stagflationary Mark said...

Picture a mother who puts large pillows all around a trampoline. The child learns to jump higher without risking injury. Now picture the mother removing the large pillows.

Jazzbumpa said...

Mark -

I got the analogy. What I'm missing is how it applies to the situation. Throughout the great moderation, regulation was decreased, up to the final blow of undoing Glass-Steagall.

Unless you're saying the golden age was over-protective, and that encouraged enormous risks. I can't go along with that.

The protections prevented the recklessness, they didn't promote it as I think you're suggesting.

Or am I missing the point?


Stagflationary Mark said...

Regulation is just one form of protection and I agree that it was reduced. There's a bigger protection though and that protection has only increased. I am arguing that the protection offered to big banks has never been higher.

Just look at our "banks too big to fail" model. We let banks jump as high as they wish upon the trampoline under the belief that we will always catch them if they fall.

That's the kind of protection I'm talking about. Bad plan.

During the crisis, our government mother was so overwhelmed (so many of her banking children were falling off the trampoline) that she actually sacrificed Lehman Brothers to the Risk Gods. Based on the results, I doubt she tries that again.

Lehman Brothers

Investment banks such as Lehman were not subject to the same regulations applied to depository banks to restrict their risk-taking.

April 17, 2009
Yellen Signals Letting Lehman Collapse Was a Mistake (Update1)

April 17 (Bloomberg) -- Federal Reserve Bank of San Francisco President Janet Yellen signaled that it was a mistake to allow Lehman Brothers Holdings Inc. to collapse, saying the firm was “too big to fail” and its bankruptcy caused a “quantum” jump in the magnitude of the financial crisis.

So let me fine tune my analogy.

Regulations prevent jumping on the trampoline. The mother is not doing that. She lets her children jump as high as they want in the hopes that her massive deployment of "safety nets" can prevent damage when they eventually fall.

Overall, she's extremely overprotective (in a bad way) and it inspires all kinds of risk taking.

The Arthurian said...

Mark -- "Just look at our "banks too big to fail" model. We let banks jump as high as they wish upon the trampoline under the belief that we will always catch them if they fall."

But protection of the banks is protection of the economy and of paycheck-to-paycheck people like me... Given that we go with the TBTF model, the protection is essential. The only alternative I see is to stop encouraging bigness and start encouraging smallness in business.

Jazz, to me the Great Moderation is an invention of economists who wanted to pat themselves on the back for creating the economy that would give us Great Depression #3. Not sure it's worth the effort you put into evaluating it. Obviously, you see the GMod as something other than what I see.

"I will say that extended recession-free periods lead to lower RSD."

Good observation.

"Rather than something remarkable, the Great Mod might just be a return to relative normality."

Back in April I observed that "The smallest year-to-year change [in GDP] during the Free Banking era was 44% larger than the smallest comparable change during the Golden Age. The biggest year-to-year change during the Free Banking era was 42% larger than the biggest change of the Golden Age."

This goes back to your "theory that the Great Mod was a data artifact of declining GDP growth." The older era was less "moderate" than the 1947-73 period.

Jazzbumpa said...

Mark -

Now I get it, and I agree.

Art -

This is all background for a project I'm working on.

Protecting the banks and dereg go hand in hand. With Glass-Steagall still in place, and Phil Graham's other dereg laws not enacted, 1) paycheck people like you would never have been at direct risk because banking functions wold have been separated, and 2) the entire financial meltdown of 2007 would have been avoided.

The Great Recession can be laid squarely at the feet of Graham, Greenspan and Summers.


The Arthurian said...

re: deregulation, there is an interesting graph on page 3 of the PDF here


The Great Recession can be laid squarely at the feet of Graham, Greenspan and Summers.

Agreed... but.