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Chapter 17: Q2. (page 625)

Why did the Great Recession lead to the decline of the Great Moderation consensus? What is the current state of consensus among most economists?

Short Answer

Expert verified

Due to the ineffectiveness of monetary policy, Great Moderation consensus declined, and the current condition of consensus is that most economists agreed that fiscal policy is more effective than monetary policy.

Step by step solution

01

Step 1. Explanation of decline of the Great Moderation consensus and the current condition of consensus

The Great Moderation consensus mainly persisted from the 1980s until the Great Recession, and monetary policy was always used to retain the consensus in the economy. During the Great Recession, this consensus failed with the failure to implement the expansionary monetary policy.

As far as the current consensus is concerned, most economists believe that the fiscal policy is very effective compared to the monetary policy as the monetary policy remained ineffective in controlling any crisis. Still, the fiscal policy remains very effective in rejuvenating any economy from a crisis.

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Most popular questions from this chapter

What are the limits of macroeconomic policy activism?

In a press release during the Great Recession, the National Federation of Independent Business, which calculates the Small Business Optimism Index, stated "The Small Business Optimism Index rose just 0.1 points in January… . Historically, optimism remains at recession levels. While small business owners appeared less pessimistic about the outlook for business conditions and real sales growth, that optimism did not materialize in hiring or increased inventories plans." Would this statement seem familiar to a Keynesian economist? Which conclusion would a Keynesian economist draw for the need for public policy?

Question: Why did the Great Recession lead to the decline of the Great Moderation consensus? What is the current state of consensus among most economists?

Starting in 2008, as the economy entered the Great Recession, unemployment soared while interest rates and investment spending fell sharply. The Fed accelerated the growth of M1 in response.

a. What effect would these events have on the velocity of money? Do you think Milton Friedman would have agreed with the Fed's policy?

b. Monetarists, like Friedman, generally believe that discretionary monetary policy and fiscal policy are ineffective. Do you think their objections to fiscal and monetary policy were valid during the Great Recession? Note that unemployment did not return to its pre-recession level until 2016.

In late 2008, as it became clear that the United States was experiencing a recession, the Fed reduced its target for the federal funds rate to near zero, as part of a larger aggressively expansionary monetary policy stance (including what the Fed called quantitative easing). Most observers agreed that the Fed’s aggressive monetary expansion helped reduce the length and severity of the Great Recession.

a. What would rational expectations theorists say about this conclusion?

b. What would real business cycle theorists say?
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