Fund managers seem to have fallen in love with “the great moderation” judging by this month’s Merrill Lynch survey. Over the past 18 months, they apparently believe, the business cycle has hardly moved. Economic conditions are remarkably stable and, in their view, are likely to stay that way.
More broadly, experts from Ben Bernanke, the governor of America’s Federal Reserve, downwards have discussed the great moderation across the industrialised world. The volatility of economic growth and inflation, among other indicators, has plummeted. In some countries, most notably Germany, the trend is apparent from the 1970s, while in others it manifested itself in the 1980s.
There are two opposite conclusions commonly drawn from such observations. One is that we live in a golden new era in which stability looks set to stay. The contrary view is that eventually trouble will manifest itself. Both outlooks are one-sided.
On the one hand, the argument that all will remain benign is too easy. Its appeal is understandable but for that reason it should be treated with suspicion. On the other hand, it does seem that something fundamental has changed. The sharp and international coordinated fall in economic volatility is a dramatic development. The problem is that the three main explanations for the fall in volatility are not convincing.
The first, and probably most popular, explanation is that monetary policy has become more astute. In this view, the skill of central bankers in targeting inflation has played a key role in reducing volatility.
Such an argument confuses cause and effect. It is the stability of the economic cycle that has made life easier for central bankers. The Alan Greenspans and Mervyn Kings of this world are beneficiaries rather than creators of the trend.
Another explanation is structural changes such as improvements in the way businesses manage their inventories. But it is hard to imagine technical changes such as this having such a dramatic effect.
Finally, a significant number of economists attribute the shift largely to good luck. However, although luck has a role in life, it is difficult to see how it could account for such an internationally pervasive and dramatic shift. The real key is likely to lie in the demise of intense social conflict across the developed world. Even recent events such as the riots in Paris are relatively small-scale compared with the social tensions that were once common.