Skip to main content
The FRED® Blog

Moderately well understood

The Great Moderation is evident, but its causes are complex

For decades, economists have puzzled over the reduction in macroeconomic volatility in the U.S. and world economies after the mid-1980s: In the last 25 years or so of the 20th century (highlighted by the blue bar in the graph), domestic output, employment, and inflation all fluctuated far less than they had in prior years. The data make the stabilization of the economy clear, yet economists haven’t reached consensus over the causes or duration of the Great Moderation.

The Federal Reserve points to monetary policy as a primary cause of the moderation, through orderly responses to inflation and GDP changes after the Great Inflation of the 1980s. Instead of waiting for the signs of economic recession or rising inflation to appear before acting, as was common in the “go-stop” practices of the 1960s and 1970s, the Federal Reserve began following a more systematic, rules-based approach. Another proposed cause is the structural change of the economy and the labor market. In the 1980s, labor patterns shifted away from manufacturing and toward less-volatile sectors. Also, new technology sped up communication and allowed producers to track inventory and demand more easily, leading to more stable output over time.

It’s easy to look to clear economic and policy changes as contributors to the Great Moderation, but there may be another factor at play: luck. Statistical models such as those proposed by Stock and Watson or Galí and Gambetti assert that, although some economic shocks did occur during the early part of the Great Moderation, they were less severe and better handled than those of the 1970s. While others dispute this claim, it still brings to mind the question: If luck is responsible, how long will it last?

There’s no answer yet to the question of whether the Great Moderation ended with the recession of 2007-09 or was merely temporarily disrupted by it. If we assume that structural and policy changes brought about the reduction in volatility, then, as long as those are maintained, the moderation ought to continue. However, if good fortune is responsible, we may still be waiting for the next shock that will bring about another increase in instability.

How this graph was created: Search “Real GDP” and select the relevant series. From the “Edit Graph” tab, click “Add Line” and select “Create use-defined line.” Set the date range from 1983 to 2017 and set both the start and end points as zero.

Suggested by Maria Hyrc and Christian Zimmermann.

View on FRED, series used in this post: A191RL1Q225SBEA

Treasuring cash

Why does the U.S. Treasury have so much cash at the Fed?

The graph above shows the operational account that the U.S. Department of the Treasury has with the Federal Reserve. This account is basically equivalent to the checking accounts individuals and businesses have with their banks. Indeed, the Federal Reserve acts as the U.S. government’s bank. And this account has plenty of funds to take care of expected cash payments, check clearing, and outstanding wires. In general, though, it’s a good idea to prevent an account balance from getting too large. The balance could be used to reduce debt or be spent on goods and services instead of earning very little interest. Yet, this account has had substantial balances since 2008, and they keep getting larger. Why?

The answer has to do with the Treasury’s response to the financial crisis of 2008. The Treasury assisted the Fed with the Supplementary Financing Program (SFP). In September 2008, the Treasury began issuing short-term debt and placing the proceeds at the Fed. This helped offset the large balances that other banks were holding at the Fed. The SFP has been empty since July 2011; yet, there are still large cash holdings to this date. There are two reasons for this: First, late in 2008 the Treasury suspended its cash reinvestment program. It used to make short-term loans to banks that needed liquidity. Given low interest rates and the fact that banks have been holding excess reserves, this program hasn’t been necessary, and so the Treasury is holding more cash. Second, since late 2015 the Treasury has been purposefully holding more cash to be prepared for any major disruptions, such as a potential cyber event or a systemic event like the crisis in 2008.

How this graph was created: Search FRED for “Deposits with Federal Reserve” and add the series to the graph.

Suggested by Glen Owens and Christian Zimmermann.

View on FRED, series used in this post: WTREGEN


Subscribe to the FRED newsletter


Follow us

Back to Top