A New Look at Real GDP - Part 2

Part 1 took a hard look at GDP growth after 1955.  Part 2 will take a hard look at Volatility.  The usual measure of volatility is the Standard Deviation.  Graph 1 is a scatter plot of Standard Deviation [St Dev] vs RGDP growth over an 8 year period.  The X-axis value is the average RGDP over the previous 8 years [32 quarters] while the Y-axis value is the standard deviation of RGDP growth over the identical period.  There's nothing magical about using an 8 year period, you get a similar picture using a 15 year period.

Graph 1 - RGDP Growth and Volatility

When I looked at the 15 year graph I noticed something that made me want to use an 8 year period, and that is the data trend over presidential terms.  The last data point in the term represents the performance of a given 8-year administration, and the trend over the term can offer contrast to other administrations.

Since the major trend over time has been decreases in both RGDP and St Dev, the data set starts at the upper right, and moves generally down and to the left over time.  The blue points at the start of the data set represent the Kennedy-Johnson administration from 1963 on.   JFK inherited high volatility from Ike, and during the Democratic term, RGDP growth increased while volatility decreased from 2.95 to 2.09.  During Nixon-Ford [purple], volatility jumped back up to the 2.5 range while average RGDP growth plummeted from 4.8 to 2.7%.  During the Carter administration [light blue], RGDP growth increased to 3.6%, then fell again, while volatility remained fairly constant in the 2.5 to 2.7 range.  Interestingly, the moribund Carter administration at it's best gave us average RGDP growth equal to Reagan's, at it's best, with much lower volatility.

During Reagan's term [red], RGDP growth fell, then rose. Both RGDP growth and volatility reached their maxima in Q4, '84 at 3.5% and 3.06, respectively.   During George H. W. Bush's term [yellow], average RGDP and St Dev didn't change much, despite the sharp RGDP drop in 1991.  By Q2, '95, RGDP growth stabilized, and grew slowly from there for the rest of Clinton's term [blue] while volatility dropped dramatically from 2.5 at the begiining of the term to 1.3 at the end.  During the George W. Bush term, volatility remained low while average GDP growth took a nose dive from 3.8 to 2.3%.

Then the Great Recession happened, and during Obama's term we've seen RGDP growth and volatility both stabilize.   While the Std Dev has settled in at an intermediate level, average RGDP growth has never been lower during the period under study.

This demonstrates what I've believed for a long time:  the Great Moderation is a myth.  The only meaningful declines in St Dev took place during the Kennedy-Johnson and Clinton administrations - what I call the two little moderations.  You can attribute this to good policy or good luck.  But the Great Stagnation is real.  Only during the Kennedy-Johnson and Clinton administrations did we experience increasing GDP growth along with falling volatility.

Now, I'm gong to introduce the concept of Relative Standard Deviation [RSD] this is simply the standard deviation divided by the average of the data set on which it is based.  You might think this is a novel concept, but analytical chemists and quality engineers use it all the time.  Think about it this way.  If the St Dev is two and the data is clustered around 10 that's one thing, but if its clustered around 2, that's something quite different.  The denominator provides context for the numerator.

Graph 2 shows the RSD of RGDP growth, again based on a moving 8 year kernel.

Graph 2 - Relative St Dev of RGDP Growth

I've included the grand average [0.735] in yellow and some trend lines. At the beginning of the series, RSD falls sharply to a low of 0.418 in Q4, '69.  From there it's a bumpy rise to the top at 1.35 in Q4, '82.  But the value remains below the average for 9 years from Q4 '65 to Q4, '74.  Following the peak, there is no meaningful breach of the average again until Q1, '97.   In other words, after the peak, volatility remained high for 7 years, and at or above average for 15.  From 1990 through '96, the values cluster close to the average line.  After that, values stay below average until Q4, '98, 12 years later.  What we have are two roughly symmetrical, approximately decade long periods of low volatility - the little moderations - surrounding two above average decades that include two volatility bumps and one brief excursion into ultra-high high volatility in 1982-3.  The low volatility of the little moderations results from avoiding recessions - periods when volatility goes up while GDP growth declines.  The 1982 peak is an artifact of the double dip recessions of  '80 and '82. The whole key to having low volatility has been, up until recently, to avoid recessions.

As I said, I think the Great Moderation is a myth.  It's entire existence is predicated on 2 things: 1) a brief ultra-high volatility blip due to a double dip recession; and 2) completely ignoring the existence of the first little moderation. 

But what's happened since is truly remarkable.  We now have what some people consider to be [and applaud as] remarkably stable GDP growth.  But what we actually have is the lowest non-recessionary GDP growth ever recorded, coupled with historically high RSD.  This is a truly ugly economic environment.  Anyone graduating now is the unluckiest of all.