The Timing of This AEJ:M Article Must Be the Worst Ever

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It is hardly surprising that the American Economic Journal: Macroeconomics greatly interests the GEM Project. The relatively new journal, first appearing in the winter of 2009, provides a real-time record of the unhappy run of the New Keynesian (NK) dominance of macro theory. Failure was on full display in the initial issue, which featured what is surely the worst-timed macro-theory article of the 21st century: “On the Sources of the Great Moderation” by Jordi Galí and Luca Gambetti, hereafter G&G. The authors sought to advance an idea already familiar  in the NK literature, the existence of a great moderation in the U.S. economy that conveniently began in 1984 and produced “a substantial decline in the volatility of most macroeconomic time series”.

From the paper’s short abstract: “The Great Moderation in the US economy has been accompanied by large changes in the co-movements among output, hours, and labor productivity. Those changes are reflected in both conditional and unconditional second moments as well as in the impulse responses to identified shocks. Among other changes, our findings point to an increase in the volatility of hours relative to output, a shrinking contribution of nontechnology shocks to output volatility, and a change in the cyclical response of labor productivity to those shocks. That evidence suggests a more complex picture than that associated with ‘good luck’ explanations of the Great Moderation.”

How embarrassing must it have been to G&G that their article appeared in early 2009 in the midst of a frightening collapse of asset prices, total spending, employment, and production. Later named the Great Recession, 2008-09 ranks with the  most perilous periods of extreme instability in U.S. history. Many economists, including Ben Bernanke and his Fed staff, and most market participants believed that the severe “volatility of most macroeconomic time series” gravely threatened a 1930s-class depression that would make the earlier calamity look like a walk in the park. What mainstream macroeconomists were wishfully thinking was fundamental structural stability turned out to be the most dangerously unstable economy of their lifetimes. All proponents of the Great Moderation looked foolish, but only the luckless G&G published in the middle of the extreme volatility.

I have always wondered what was going on during the launch of the AEJ:M. The timeline of the Great Recession is from late-2007 to mid-2009. Surely that provided sufficient time to remove the LOL great-moderation article from the winter 2009 AEJ:M. The choice to publish seems to be some blend of editorial cluelessness about what was actually happening and cruelty to the authors.

As noted, the humiliating diagnosis was not original with G&G. I believe it was initially offered, gathering notice, by a former colleague of mine at MIT. Robert Hall wrote a series of papers after the turn of the century that separated U.S. recessions into two chronological classes. He asserted a metamorphosis, largely unspecified, of cyclical downturns into their “modern” form sometime after the challenging 1981-82 contraction. From Hall (2005a): “In the modern U.S. economy, recessions do not begin with a burst of layoffs. Unemployment rises because jobs are hard to find, not because an unusual number of people are thrown into unemployment.” That passage has always been startling to any macroeconomist with serious practical experience and is quoted in the ill-fated G&G paper. Hall argued that in “modern” recessions familiar labor-market search/match theory, with its focus on voluntary unemployment that occurs while looking for “hard-to-find” jobs, now provides adequate explanation of actual labor cyclicality. Hall brazenly concluded that, once embedded in the micro-coherent, market-centric general-equilibrium framework, the voluntary unemployment of search/match modeling would become the focus of operational stabilization theorems.

Our capacity to assess the great moderation hypothesis was made more robust with the expansion of the recession sample size from two to three.  The table shows the 2007-09 recession (by definition part of Hall’s modern class of business cycles) to have been severe, with its outsized labor-market deterioration dominated by job losers. The six million involuntarily lost jobs accounted for more than three-quarters of the increase in total unemployment, pushing up the job-loss incidence by 13 percentage points. People who were, in Hall’s words, “thrown into unemployment” were the overwhelming cause of the devastating jump in joblessness. The evidence is conclusive. The Great Moderation was implausible pie-in-the-sky.



Monthly Peak-to-Trough Change in:

Unemployment Rate   Job-Losers Incidence   Job Losers (000)


1969-70                   +2.4 points                   +8.2 points                  +1,230

1973-75                   +3.8 points                 +16.0 points                  +2,599

1980                        +1.5 points                    +7.4 points                 +1,315

1981-82                   +3.6 points                 +11.2 points                  +3,433

1990-91                   +1.3 points                   +6.8 points                  +1,373

2001                        +1.2 points                    +6.0 points                  +1,423

2007-09                   +4.8 points                  +13.1 points                  +5,807


The 2007-09 extreme instability reduces the analytic value of the great moderation hypothesis to little more than illustrating the Ptolemaic-eagerness of NK theorists to claim some policy relevance for their stabilization-challenged friction-augmented general-market-equilibrium model class. (Recall that still mainstream theory cannot rationally accommodate involuntary job loss, forcing the academy to ignore the important phenomenon and model only the mildest cyclical contractions.) NK theorists, especially in their mainstream gatekeeping activities, must face up to the reality that macrodynamic instability can be both severe, generating huge welfare costs that must engage stabilization authorities, and incompatible with rational-behavior market-centric analysis. Useful macroeconomics requires mainstream theorists start thinking outside the consensus box in which all rational exchange is restricted to the marketplace.

Blog Type: New Keynesians Saint Joseph, Michigan

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