26 Jun 2012

Sample Essay: Recessions in the United States and the Great Moderation


Recessions surge the degree of insecurity within a society and several provoke fears and speculations. Questions such as, why are recessions not thwarted by economists and policy regulators before they occur? Are they caused by defaulting financial intuitions? Why can countries not prevent recessions by strictly governing its potential perpetrators? The essence of all these questions is, why does a recession occur, and why can we not foresee and stop it? However, the answers are many. Intense speculations and fears can cause the stock market to crash. A change in a trading partner’s foreign policies can significantly affect a country’s economy and cause inflation. An economical crisis in an acknowledged economic power can cause a recession in many other countries. Recessions can also occur when the government in a country collapses, either due to a coup d’état or due to the sudden death of a prominent leader. Similarly, the natural disasters, terrorist attacks, or wars can also cause recessions. It can be concluded that the fear of recessions stems from the fact that they degrade the lives of the common people due to factors, such as, rising unemployment rates, national debts, and the plunging valuation of a country’s currency. This paper attempts to analyze the nature of recessions by studying three periods of economic recessions in the United States: 1980–1982, 1990–1991, and 2001. As has been mentioned before, covering all the aspects or reasons behind recessions is difficult, and thus, for the purpose of this paper, Ben Bernanke’s analysis of the Great Moderation will be employed. To begin with, the Keynesian policy of economics—that views changes in the collective demands and thus, increases in spending habits as the powerhouse that propels economic growth—is considered.

Keynesian Policies and Recessions

As its name suggests, the Keynesian policy was developed or propounded by British economist John Keynes, whose work, The General Theory of Employment Interest and Money at the turn of the nineteenth century changed the way economic policies were viewed until then (Boyes and Melvin, 2010, p 218). Keynes pointed out that an economy could be in a state of equilibrium with a GDP that is less than its potential, and that in times of a recession, governments should change their economic policies in order to curb the recession (Boyes and Melvin, 2010, p 218). At a time when people believed that the government should not be directly involved in the macroeconomic policies of a country, Keynes showed that an economy cannot simply subsist on private expenditures—especially during a recession (Boyes and Melvin, 2010, p 218; Buchanan, 1977, p. 10). He imparted the knowledge that the governments should start spending more to initiate monetary outputs and incomes (Boyes and Melvin, 2010, p. 218; Buchanan, 1977, p. 10). In other words, he believed that the fear of a recession makes people want to hoard their money without trusting the banks to keep it safe for them, and this only further destabilizes the economy. Thus, to instigate people to spend and invest, the government should make changes in its policies, such as decreasing interest rates.

Research analyst, Laura Summers (2009) echoes these facts in her article on the subject. She states that the Keynesian theory views recessions as being engendered from disorders—such variability in oil prices, wars, or natural disasters—within the economic system, which affects the aggregate demands, especially in terms of investments (2009). Consequently, the situation becomes compounded by the reactions of the investors, the public, and the government. Saving within households, which is generally regarded as an indication of a healthy economy, only further worsens the recessions. Thus, a “negative feed-back loop” is created and the situation develops into a “paradox thrift” (Summers, 2009). With less money circulation, unemployment rates increase as companies have less money to spend due to decreasing consumption levels and investments. In 1977, Buchanan (p. 129) presented his proposal based on the Keynesian policy that for maintaining stability in an economy, the government should present budgets that transparently show the national targets against the expenditures, which should be followed to the tee unless there is a national emergency.

The Recession of 1980–1982

The recession of the early 1980s actually began in the 1970s and affected most of the globe in its onslaught. In the United States, the economic downfall was caused by more than a single factor. Among the many factors that contributed to this recession, the Iranian Revolution that surged up the oil prices is the most well known (Meltzer, 2010). The energy and oil crises in the 1970s accrued to bring in the inflation in 1980–1982 (Meltzer, 2010). This is direct opposition of the less number of shocks in the following period of the Great Moderation, when there were relatively lesser shocks (Bernanke, 2004). It should also be remembered that the United States was involved in an intense cold war with the communist world in this period, and that tensions were compounded by the increasing threat as both sides gained access to nuclear power—another shock. It is thus possible that the greater number of economic shocks caused this recession—in contrast to the lesser economic shocks during the Great Moderation (Bernanke, 2004). This recession thus became a double dip recession, possibly due to the mistakes made in deciding the monetary policies in this period. The W-shaped curve of the GDP in this period as shown in figure 1. represents this fact (The ABC’s of Recessions).

In 1979, the then newly appointed chairman of the Federal Reserve System, Paul Volcker[Editor1] , propounded a strict monetary policy that he believed would significantly aid in reviving the country from the recession (Meltzer, 2010). In between 1980 and 1982, inflation reached a high of 17 percent and a low of 5 percent as the monetary policies were being amended in the middle of the year (Meltzer, 2010). However, the high interest rates and employment rates continued until 1983 and 1985, respectively (Meltzer, 2010). Volcker because believed that inflation at 11 percent was getting out of hand, and its curbing should be the main goal of the government (Meltzer, 2010). The price inflation was indeed out of control as economists struggled to understand the difference between the projected and real inflation and juggled with various economic theories (Meltzer, 2010). The change of the gold standard into the floating form in reserves only aided in adjusting the exchange rate policies, but challenges on the domestic inflation rate front could not be met (Meltzer, 2010). Moreover, the Volker attempts to control the monetary policy during this recession actually instigated another recession. The strict monetary policies, which had been amended based on the Kyenesian theories, were brought in the middle of the financial year, and strategically poised to make their entrance during the elections. The banks had been asked to reduce their reserves a discount rated were brought down to 10 percent in 1980. Thus, there was a considerable increase in monetary aggregates for about five months in 1980, but once the effects of the disinflation began to be felt, the cracks of the recession began appearing again. From all these factors, it would seem that Bernanke’s (2004) observation that a recession can be caused by economists who have defaulted because they were unable to understand the economy well could be true for the 1980s recession.

The Recession of 1990–1991

Bernanke (2004) states that the three reasons for the Great Moderation that followed the 1980–1982 recession are favorable changes in the monetary policies of the country, structural changes in the economy, and good luck. The factors mentioned above show that Bernanke’s (2004) observation that the output volatility and inflation volatility increases in the 1970s and early 1980s corresponded to the poor monetary policies. Only once the macroeconomic volatility was reduced at around 1984, did the Great Moderation begin to spread roots (Bernanke, 2004). Thus, the global recession of the early 1980s ended fairly early in the United States, but it severed the power of the communists by bringing an end to the Soviet regime. The United States thus thrived in a long period of peace in the later part of the 1990s. Good monetary policies, the factor Bernanke (2004) seems to favour the most, were perhaps the most significant contributing factor for the Great Moderation. Nevertheless, the ability of a good economic structure to prosper without any economic shocks cannot be ruled out as reason for the low macroeconomic volatility of the Great Moderation (Bernanke, 2004). Thus, at the beginning of the 1990s, the United States’ economy was at its peak, but by July 1990, the country went into an eight-month long recession, and it emerged from it in March 1991 (Stock and Watson, 2002, p. 159).

The[Editor2] actual commencement of this recession can be traced back to 1987, when stock markets across the world crashed miserably (Browning, 2007). In the United States, this impact was felt relatively low, as with the elections around the corner, the reactions to this recession were almost missed. Browning (2007) states that no one remembers this recession because it did not “seriously hamper economic growth.” Thus, as Bernanke (2004) would state, the lesser number of shocks buffered the economy from a complete downfall. However, while the impact of the recession was not felt at the beginning by mid-1990, as the Gulf War gained momentum and oil prices increased, there were a few months of recession (Browning, 2007).

While the shocks were, however, felt gradually, the consumer buying behavior saved the country from suffering excessively in this period. Bernanke (2004) mentions that after the 1981–1982 fiasco, the methods by which central banks should charge interest rate became an important matter. Economist John B. Taylor developed a model based on the price and wage of the time using the Keynesian models. Bernanke (2004) believes that the employment of this model for deciding nominal interest rates could also be a significant reason behind the Great Moderation. It can also be viewed that the low impact of the 1990–1991 recession (and even the 2001 recession, as has been mentioned ahead) was due to the effectiveness of the Taylor curve model.

Stock and Watson [Editor3] (2002, p. 199–200) believe that while there were strong indications of decline in the volatility of economic activity, the real GDP had significantly decreased in the middle of 1980s. This, they state, was apparent in the difference in the rate of consumption, production of durable goods, residential fixed investment, and in the production of structures across all quarters. Thus, it can be seen that this recession did not actually affect all sectors. They too are in agreement with Bernanke (2004), who was the chairperson of the Federal System of Reserves in this period, that there is no clarity about the reasons behind the Great Moderation. They believe that it could be the improved monetary policy or Federal System changed response to the inflation from the mid-1980s onward that might be some of the reasons. They also agree with Bernanke (2004) on the point that whatever the reasons behind the Great Moderation, it did help in reducing the output volatility, which is known to edge an economy towards a healthier path.

The Recession of 2001

The recession of 2001 has been called a “short” and “shallow” recession like the 1990–1991 recession (Kliesen, 2003, p. 23). Like the 1990–1991 recession discussed above, it was occurred after a period of economic expansion and ended in November 2001, before its actual impact could be felt with full force (Kliesen, 2003, p. 23). Figure 2 shows a U-shaped GPD in the 1990–1991and 2001 recessions, an indication of typical recessions that are preceded by a period of economic expansion followed by a downfall and recovery (The ABC’s of Recessions). In fact, this does give rise to the question if every period of expansion should be carefully regulated because of the recession that can potentially follow in its aftermath (Kliesen, 2003, pp. 23–24). As the National Bureau of Economic Research states that to be called a recession, a economic downturn should last for at least nine months on an average, this “recession” falls short by this benchmark (Kliesen, 2003, p. 23). It is found that this recession was somewhat a shock to the economists (Kliesen, 2003, p. 27). Thus, economic forecasters had had overestimated the ability of the economy in this period (Kliesen, 2003, p. 27). Moreover, it was wrongly estimated that the economical growth after September 2001 was expected to decline (Kliesen, 2003, p. 27). Like the recession of 1990–1991, varied consumer spending resulted in some sectors getting affected by the recession more than the others (Kliesen, 2003, p. 28). An unexpected decline in the net exports due to the appreciation of the USD and a worldwide decline in slowdown in economic activity also contributed to this recession (Kliesen, 2003, p. 27).

Toward the end of his speech Bernanke reinstates his faith in the ability of the good monetary policies to thwart of buffer the impact of a recession by stating that even the favorable shifts in the Taylor curve in the Great Moderation period could have been instigated by good monetary policies. He makes four statements that stand by his opinion on this: (1) The monetary policies could have stabilized inflation, which in turn stabilized the structure of the economy. (2) Although shocks are thought to be exogenous events, many-a-times, these shocks are actually instigated by expansionary monetary policies. (3) A good monetary policy can also safeguard the economy against shocks by being sensitive to the distribution of the shocks. (4) Finally, alterations in the inflation expectations are actually perpetrated by monetary policies and often mistaken to be exogenous shocks, and so, a good monetary policy will negate this effect. In the 2001 as well as in the 1990–1991 recessions, the low impacts on the economy were owing to the same policies that were being followed in the wake of the 1980–1981 recessions, that is, in the Great Moderation period. Thus, the four points stated by Bernanke above could very well be the reason behind these low-impact recessions.


Using Bernanke’s analysis, it can be observed that in the recession of 1980–1982, the economists were probably unable to understand the economy well enough to take appropriate steps to safeguard it. It can also be concluded that the increased inconsistency in the economy, that is, more economic shocks could have furthered the decline of the economy in this period. The exact contrasting factors were found to be the reasons behind the Great Moderation in the following period. The next recession, that is, the one between 1990 and 1991, was a short one and almost neglected by the people of the country. However, economic volatility has been said to be the contributing factor behind this recession. It is also found that Bernanke’s (2004) concepts regarding the Great Moderation—that the improved monetary policies were crucial to the growth in this period—are in coherence with the findings of other researchers. The 2001 recession is comparable to the 1990–1991 one in that it resembles the short duration for which it lasted and the fact that it was followed by an period of economic expansion. It can, however, be concluded that finding the causes behind recessions is extremely difficult, and while improved monetary policies are an potential cause behind an expanding economy and vice versa, this fact cannot be marked on stone. Moreover, it can also be seen from the 1980–1982 recession that Keynesian theories, while relevant even today, should not be adhered to blindly. The Taylor curve, a important model based on the Keynesian theories has been known to be helpful in deciding the nominal interest rates of central banks. It is possible that this model was responsible for buffering the United States from the recessions of 1990–1991 and 2001 as well as for aiding the prosperity of the country’s economy during the Great Moderation—although Bernanke favors monetary policies as the major contributing factor.


Browning, E.S. “Exorcising Ghosts of Octobers Past: Despite Housing Slump, Crashes Such as in 1987 Likely to Stay Memories,” (October 19, 2007), The Wall Street Journal. Accessed on April 30, 2012 http://online.wsj.com/article/SB119239926667758592.html

Bernanke, Ben S. Remarks by Governor Ben S. Bernanke At the meetings of the Eastern Economic Association, Washington, DC (February 20, 2004). The Great Moderation Accessed on April 30, 2012 http://www.federalreserve.gov/boarddocs/speeches/2004/20040220/default.htm.

Boyes, William and Melvin, Michael. Economics. Eagan: Cengage Learning, 2010.

Buchanan, James M. Democracy in Deficit: The Political Legacy of Lord Keynes, Online Library of Liberty, 1977.

Kliesen, Kevin L. The 2001 Recession: How Was It Different and What Developments May Have Caused It? The Federal Reserve Bank of St. Louis (September–October, 2003), pp. 23–37.

Meltzer, Allan H. A History of the Federal Reserve—Part VIII: Volcker Imposes Monetary Austerity (1979–1986),  Futurecasts Online Magazine, 12(8) (August 1, 2010). Accessed on April 30, 2012 http://www.futurecasts.com/Meltzer,%20History%20of%20Federal%20Reserve,%20v.%202%20%28VIII%29.htm#Recession%20of%201980-1982.

Summers, Laura. Thoughts on the Current Recession: Keynesian Economics (May 1, 2009), Utah Foundation Research Brief. Accessed on April 30, 2012 http://www.utahfoundation.org/reports/?page_id=437.

Stock, James H. and Watson, Mark W. Has the Business Cycle Changed and Why? Ed. Mark Gertler and Kenneth Rogoff (April 5–6, 2002), NBER Macroeconomics Annual 2002, 17. Accessed on April 30, 2012

The ABC’s Of Recessions (August 15, 2009). Accessed on April 30, 2012 http://www.targoz.com/blog/the-abcs-of-recessions.html.


Figure 1. The W-shaped GPD of the 1980–1982 recession shows that this was a double-dip recession

1980–1982 W Recessions

Source: The ABC’s Of Recessions (August 15, 2009). Accessed on April 30, 2012 http://www.targoz.com/blog/the-abcs-of-recessions.html.

Figure 2. The U-shaped GPD of the 1990–1991and 2001 recessions shows that they were typical recessions with a period of economic expansion followed by a downfall and recovery

1990–1991 & 2001 U Recessions

Source: The ABC’s Of Recessions (August 15, 2009). Accessed on April 30, 2012 http://www.targoz.com/blog/the-abcs-of-recessions.html.


Bernanke mentions him as well.

[Editor2]I have followed the pattern of mentioning the major attributes of each of the recessions and comparing them to Bernanke’s observations. So, the 3 basic reasons (2 if you look at the good luck factor as a consequence of the lesser number of shocks) for the Great Moderation have been mentioned for all the recessions. So Bernanke is present everywhere!

[Editor3]This is a study that agrees with Bernanke’s observations.

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