Tuesday, July 28, 2015

"Inflation pushes new borrowing up"

That's what I said yesterday: Inflation pushes new borrowing up.

Because things cost more than before. So if we don't change our habits, if we just keep doing the same portion of our spending on credit, then the dollar amount of that portion will rise with inflation. No mystery there.

If "we" happen to be the Federal government, our borrowing is similarly affected by inflation: If we just keep doing the same portion of our spending on credit, then the dollar amount of that portion will rise with inflation.

Federal government or no, there may be other reasons for our new borrowing to rise or fall. Reasons other than inflation. For example, we may choose not to keep doing the same portion of our spending on credit. I'm trying to separate out the inflation from these other reasons.


I want to start with FRED's FYGFD, Gross Federal Debt. Graph #1 shows the annual change in Gross Federal Debt, billions of dollars. I'm using it as a measure of the annual deficit of the Federal government:

Graph #1: Year-to-Year Change in the Federal Debt, a Measure of Deficits.
You can look at this graph a couple different ways. You can say the numbers really start going up fast right around 1980. And that's true. But if we chop off everything since 1980 and look at the years before that ...

Graph #2: Wow, the numbers really start going up fast around 1975!
... we might want to say "Wow, the numbers really start going up fast around 1975!"

But then, if we chop off everything after 1970 and look at what's left, we could say "Wow! the numbers really start going up fast around 1966!"

Graph #3: Wow! the numbers really start going up fast around 1966!

And if you look again at that graph, you might happen to notice that the numbers were trending upward right from the start.

All these important facts get squished down to nothing when the graph includes the more recent numbers that are, indeed, much larger nominal values.

Now let's go back again to the graph that goes all the way to year 2000. Graph #1. Let's keep that blue line as is, and put the same debt data on there again -- this time in red. But this time we'll take that red line, annual change in the Federal debt, and take the inflation out of it.

I divided the annual deficits by the GDP Deflator. It's the same exact calculation you would do to convert nominal GDP to inflation-adjusted GDP. Except of course the data we start with is deficits, not GDP. Here is the result:

Graph #4: Annual Deficits (blue) from Graph #1, and the Same Deficits with Inflation Stripped Away (red)
With inflation stripped away, the deficits are higher. Doesn't that strike you as odd? It always bothers me. Inflation makes prices higher, so when you take inflation out of the numbers, the numbers should be lower.

The reason the numbers are higher is that we're looking at years before the "base year". The base year is 2009. (It's not even on the graph.)

Here's the thing: In the years after 2009, the dollar was worth less because of inflation, so the red line is lower than the blue. But in the years before 2009, the dollar was worth more than a dollar in 2009. So the red line is higher. Simple, right?

I hate it.

The years after the base year are okay. The numbers with inflation in them are higher than numbers without. That makes sense. But in the years before the base year, numbers with inflation in them are lower.

Look: I can explain it and convince myself that it is right. That's not the problem.The problem is, every time there is a graph that compares real values and nominal values, I need the explanation to go with it. Explanations make people's eyes glaze over, and they lose interest.

The confusion arises from the base year. The base year is too recent, too close to the present day. The base year needs to be back at the start of the data. Then we would be looking at the years since the base year, and we would see inflation pushing the numbers up. And there would be none of this confusion about inflation making prices lower in the years before the base year.

At the start, prices were X. Since that time, prices went up. Now, that's simple. You don't have to have an explanation to make it make sense. So I want to push the base year back to an early date. That's just the opposite of what economists do, of course.

Suppose I take Graph #4, the real-and-nominal comparison graph, and change the base year from 2009 to 1958. Why 1958? Because when I first started looking at economic data in the 1970s, the base year was 1958. So I'll keep it there.

I'll just keep it there. When you take the inflation out of a data series, you divide that series by the deflator series. And then you multiply by 100 to bring all the numbers up and make the base year right. That's because the base year is always given the value 100. (You can see it on Graph #4, the text in the left-hand border, we are dividing by Index 2009=100. They set up the deflator so that 2009 has the value 100.

Other years have other values. In particular, the year 1958 has the value 17:

Graph #5: Values of the GDP Deflator

It happens to be a nice round number, but that doesn't matter.

So what I'm gonna do is, instead of multiplying by 100 to bring the adjusted numbers to the 2009 level, I'm going to multiply by 17 to bring those numbers up to the 1958 level. We're still looking at the most recent deflator values, but I'm changing the base year from 2009 to 1958:

Graph #6: Federal Deficits (blue) with Inflation Removed (red) Base Year=1958

Compare the top blue borders of Graph #6 and Graph #4. They are the same except for the first number on the second line. On Graph #6 I am multiplying by 17, to bring the red line values up to the level of 1958 dollars. On Graph #4 I am multiplying by 100 to bring the red line values up to the level of 2009 dollars.

On Graph #4, multiplying by 100 makes the red line higher than the blue line. That's what happens when you're looking at years before the base year.

On Graph #6, it is as if you are standing in 1958 and looking at two different futures. The red line shows Federal deficits with no inflation. The blue line shows Federal deficits with the inflation that we actually ended up with.

There are two areas on Graph #6 that I want you to look at. The area between the black line (the zero level) and the red line represents increases in Federal deficits for reasons other than inflation. Policy decisions and such.

The area between the blue line and the red line represents increases in Federal deficits that were due entirely to inflation.

So now I can draw a conclusion or two: Yes, inflation pushes new borrowing up. Between the mid-1960s and the early 1980s, inflation pushed the blue line up noticeably. Before the mid-1960s, the red and blue lines are indistinguishable.

Oddly however, the big increase occurs after the early 1980s.

The rate of inflation fell a lot in the early 1980s. But the dollar was worth much less after we had the inflation, than it was before. What was a $100 deficit in 1965 grew to $300 twenty years later, solely because of inflation. That's based on the GDP Deflator (which records less inflation than the CPI, for example).

Oh, sure, even with inflation stripped out of them, the deficits increased. The red line shows it. At the time of the 1982 recession the red line makes a big jump -- or, it would look like a big jump if the blue line wasn't there for comparison.

But if you take a big jump in Federal deficits, and multiply it times three to show the effect of inflation, well now you are seeing what looks like an "explosion" of deficits.


Yesterday I said:

Inflation pushes new borrowing up, but does nothing to existing debt, so it creates the illusion that deficits are exploding.

Maybe you can see it, on that last graph.

Monday, July 27, 2015

The effects of inflation

Following up on Saturday's efforts, here is Noah's opening:
The U.S. federal deficit, which had been decreasing since the end of WW2, began to trend upward beginning around 1980:

It irks me that an economist (Noah Smith) would look at a graph of debt relative to GDP, and call it "deficits". It is exasperating to see him ignore the effect of inflation and watch him misinterpret the graph because of it. And it is difficult to get people to see what I want to show them.

My Saturday post is just a little bit complicated. Just a little, tiny bit more complicated than Noah's. He talks deficits and shows us debt: He shows the accumulation of those deficits that are his topic. Then he takes that accumulation, divides it by GDP, and starts making claims about deficits.

I complicate Noah's efforts by pointing out that he fails to consider the effects of inflation:

1. Inflation pushes GDP higher, but does nothing to existing debt, so it reduces the ratio of debt-to-GDP.
2. Inflation pushes new borrowing up, but does nothing to existing debt, so it creates the illusion that deficits are exploding.

Noah ignores both these effects, and so misinterprets his graph.

Saturday, July 25, 2015

Is 1+1 the cause of 2? Of course not.

Is it a serious comment? A joke? Some weird spam? Sometimes I just can't tell.

A few months back, Noah Smith gave us Why did rich-world deficits start exploding around 1980? I gave it right back to him with They didn't:

... deficits were trending up since the 1950s. Deficits were trending up quickly since 1970. If deficits were growing quickly since 1970, why does Noah's debt graph not show increase until ten years later?

Because inflation skews the numbers, that's why.

In his post Noah offers "a theory" to explain the "explosion" of deficits that "started" around 1980. Noah has "the VCG mechanism" and "the AGV mechanism" and "a big caveat" and more. It's a big, complex explanation of something that never actually happened.

"It's really striking," Noah says, "that deficits started trending upward all over the rich world around the same time." For crying out loud, Noah: The Great Inflation was coming to an end all over the rich world at that time:

Graph #1: All Over the Rich World, Inflation Came Down in the Early 1980s
Source: Index Mundi
NOTE: Noah says deficits started trending upward in the early 1980s. But he is looking at debt relative to GDP, and he ignores the GDP component. In fact, a good part of his uptrend is due to the slower GDP growth resulting from the decline of inflation -- a decline that was seen "all over the rich world". Thus is Noah's "striking" fact explained.

High inflation erodes debt. Low inflation doesn't.

The end of the Great Inflation reduced the growth of nominal GDP. So at that time, the debt-to-GDP ratio stopped being pushed down by inflation. The ratio went up since the early 1980s because inflation was less since the early 1980s. Not because deficits suddenly exploded. The explosion of deficits (if you have to call it that) came in the 1960s and '70s, during the Great Inflation. See for yourself:

Graph #2: U.S. Deficits Increased till the 1960s, Increased Faster till the 1980s, then Declined.
There is no "explosion" of deficits beginning in the 1980s.

The explosion of deficits ended in the 1980s.

There was a recent comment on Noah's post, just the other day, from Suresh Nanjagurd. "You are making this way too difficult," Suresh told Noah. "Deficits are caused when spending > income. Pretty simple, but then I'm just a humble chemist and not an economist."

Deficits are caused when spending > income.

He is joking, I hope.


The FRED graph: https://research.stlouisfed.org/fred2/graph/?g=1vnc#
The Excel file with data from the FRED graph, my Graph #2, and some VBA code.

Friday, July 24, 2015


Mark Cuban:

I paid for school with a chain letter and I would wake up in the morning, go to my mailbox and there would be checks there. And that's how I paid for my junior year.

Is a chain letter "productive" if it pays for college?

Thursday, July 23, 2015

"Whatever I do, this is what comes out."

Source: SatinKnots

It's morose, my wife says. Wallander, the BBC television series with Kenneth Branagh as detective Kurt Wallander. (Via Netflix.)

I love the intensity of it. And maybe I'm happy to see someone more morose than I...

Near the end of the first episode, Kurt Wallander visits his father Povel, an artist. The father described his work to the son. I thought it was just wonderful, what he said, like a metaphor for something, for my writing on this blog. I went back and watched it again, and wrote down what Povel said. Then I found the quote online, too.

When you were a boy you used to ask me about my work, the painting. "Why are they always the same, Dad? Why don't you do something different?"

I could never explain. You see, each morning when I start, I think I'll do something else: this morning I'll paint a seascape, this morning I'll do a still life, maybe an abstract, just a splash of paint, see where it takes me.

And then I start. And every time I paint the same thing -- the landscape. Whatever I do, this is what comes out.

Tuesday, July 21, 2015

"Sir William Petty is known as the founder of modern statistical economics"

From Ivo Mosley's Bank Robbery: Economists and the Banking System (from Medieval times to Adam Smith) at PositiveMoney:

Petty recognised that banking increased the money supply and he recommended it for that reason ...

Petty’s recommendation of banks included no assessment of how the new money, its creation and allocation, might advantage some and disadvantage others. His preoccupation was: will the new money be put to productive use? (if so, good); or will it be frittered away in idle consumption? (if so, bad). This way of thinking has come to dominate economic thinking.

The notion of "good" debt versus "bad" debt has come to dominate economic thinking, Mosley says, and that's not a good thing.

I agree. Mostly, it is the excessiveness of debt that makes debt bad.

Monday, July 20, 2015

Suggested by the post that was suggested by Ian Tarr

At the FRED Blog, Wage stickiness. I was interested because I found the link just at the same time I was writing my recent Sticky Notes post. (Ordinarily, "sticky" doesn't do much for me.)

In the FRED Blog post (which was "suggested by Ian Tarr" -- hence the title above) we find this:

The graph above shows two time series from the Bureau of Labor Statistics: unemployment (red line) and private industry wages and salaries (green line) from the employment cost index. Note that even when unemployment rapidly doubled, the green wages line continued to rise (albeit at a reduced rate). In other words, as the economy contracted and employers sought to cut costs, they almost exclusively opted to lay off workers rather than negotiate for lower wages.

As the economy contracted, they say, employers opted to lay off workers rather than negotiate for lower wages.

Well, maybe. But tweak that green line to show the employment cost index per worker and it tells a more interesting story:

Graph #2: Unemployment (red) and Employment Cost per Worker (green)
Cost-per-worker increases rapidly before and during the increase of unemployment. As soon as the "cost per worker" increase slows down, unemployment begins to fall. In other words, the dollars that employers plan to spend on employment buy more employment when the price of employment is rising slowly, than when that price is rising quickly.

Note that increasing unemployment (red) precedes the onset of recession. Also, accelerating per-worker employment costs precede increasing unemployment. I wonder if this relation holds for a longer time period...

Graph #3:Unemployment and Cost-per-Worker, Longer Term
On second thought, acceleration of per-worker employment costs and increasing unemployment seem to begin concurrently.

Data for the green line only go back as far as 2001, so it is hard to get a good feel for what that data says. But the green line increases more rapidly while unemployment is rising, and more slowly when unemployment is falling. When employment costs increase most slowly, unemployment falls most rapidly.

Not really unexpected, but it is nice to see the expected on a graph.


The FRED post anticipates a possible objection to their analysis:
Of course, it’s possible that inflation is cutting real wages even if nominal wages aren’t changing. However, when we adjust the wages data for inflation in the graph below (blue line), the pattern remains similar. Although real wages posted a slight decline several years after the recession hit, it pales in comparison to six years of elevated unemployment.

Okay. But what happens when we adjust employment cost per worker for inflation? The pattern becomes similar to that of unemployment:

Graph #5: Inflation-Adjusted Employment-Cost-Index per Capita (green) and Unemployment


So what is the meaning of all this?

Sunday, July 19, 2015

Employment Hours in Finance

Employment hours in finance as a percent of total:

Graph #1: Employment in Financial Activities as Percent of Total
Click for Graph Source Page
From new data at FRED.

Saturday, July 18, 2015

Sticky notes

Scott Sumner:

The entire AS/AD model makes no sense without some form of wage or price stickiness. We generally assume wages and prices are sticky in terms of the medium of account.

Roger Farmer:

Leijonhufvud pointed out that the assumption that The General Theory is about sticky prices is central to this orthodox interpretation of Keynesian economics, but it is not a central argument of the text of The General Theory.