The end of the Great Moderation?

TSLombard with a note. This goes to whether today’s inflation breakout is structural or cyclical. I am still in the latter camp so think of this more as a few years of interlude as global energy rearranges itself without Russia than it is the end of the Great Moderation. Aussie households had better hope I’m right because the local housing bubble is about a pure figment of the GM that I can pinpoint.


Everyone is talking about a global recession, an issue that will become even more heated this week if the US prints a second consecutive decline in real GDP. But as I explained in my latest Macro Picture, whether economies record a “technical” recession is largely irrelevant at this point. It makes more sense to focus on what is happening in labour markets. There are two reasons why the jobs market, though lagging now, are crucial for the broader outlook. First, a decline in employment usually brings dangerous “reflexivity”, leading to more spending cuts and additional rounds of jobs losses. That is why once employment cracks, there is always massive uncertainty about the ultimate depth and duration of any downturn. Second,
central banks are extremely worried about inflation. But an economic downturn that does not involve significant job losses is unlikely to generate sustained disinflation. And given current labour shortages, we are a long way from the sort of downturn that will cause serious reflexivity or allow a genuine “monetary pivot”.

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Wild inventory swings (logistical chaos), volatile inflation, excessive reliance on manufacturing and an economy weighted towards durable goods, especially housing and autos – if all this sounds familiar, that is because it is the perfect description of the economy over the past three years. And this is why the “recession” we have today is reminiscent of the downturns we had before the Great Moderation. In fact, we have managed to combine the bullwhip inventory downturns of the 1950s and 1960s with a 1970sstyle inflation squeeze. The good news is that today’s economy does not seem to exhibit the deep underlying imbalances that have proved so deadly in the post-1980s era. Sure, asset prices surged during the pandemic; but without the excessive leverage of the early 2000s, tighter monetary policy has deflated those bubbles without causing serious collateral damage (so far).

So, we have a period of instability in the real economy, but this is not necessarily the sort of “Minsky moment” investors usually associate with US recessions. Perhaps, even, it is a taste of “a new macro regime”. With inflation likely to remain more volatile in the 2020s (partly owing to climate change) and businesses set to reconfigure their supply chains, perhaps the artificial – but ultimately deceptive – macro stability of the Great Moderation has now ended. This could mean more frequent, but perhaps less extreme, recessions with fewer underlying imbalances/“bubbles”.

Houses and Holes
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