Hamilton's find and the Phillips Curve

James Hamilton recently looked at Macrofinancial History and the New Business Cycle Facts (PDF, 55 pages). According to Hamilton,

Source: James Hamilton, from
Jorda, Schularick & Taylor

The authors find that as economies have become more leveraged, the standard deviation of output growth has become smaller, consistent with a phenomenon that has been described as the Great Moderation in the United States since 1985.

Well that's sort of a big deal. It implies that as debt grew, debt influenced GDP growth and resulted in the Great Moderation. Furthermore,

They also find that the skewness of GDP has become more negative– big movements up have become more subdued relative to downturns.

In other words, the Great Moderation wasn't really so "great". The volatility ("standard deviation") of GDP was less simply because we stopped getting the "big movements up".

Graph #1: The Great Moderation -- Output Growth No Longer Breaks the 5¼% Barrier

I think everybody knew as much. Still, it is nice to see it documented.


Remember Okun's law? When output growth doesn't go up, employment doesn't go up:

Graph #2: The Great Moderation -- Employment Growth No Longer Breaks the 3% Barrier

So Hamilton's find tells us that debt growth pushed unemployment up. Think of the effect of this on the original Phillips curve: Debt growth caused a change in the horizontal axis values. It pushed unemployment higher and farther from the origin. It shifted the curve and it raised the "natural" rate of unemployment.

To be sure, I'm the one describing a cause-and-effect relation. Hamilton quotes from the PDF that

as economies have become more leveraged, the standard deviation of output growth has become smaller

They describe correlation, not causation. And again when Hamilton quotes from the conclusion:

our core result– that higher leverage goes hand in hand with less volatility

Higher leverage only goes "hand in hand" with reduced volatility and lower growth, they say. They don't claim that excessive debt "caused" the changes.

So I'll say it: Excessive accumulated debt caused the changes: The lower growth. The reduced volatility. The increase in "house prices" since 1950. The "more severe tail events". And the shift in the Phillips curve.