Is Wikipedia pulling my leg?

Scott Sumner says "give up on that MPC stuff, it was discredited decades ago".

Paul Krugman says

It’s true that at any given point in time the rich have much higher savings rates than the poor. Since Milton Friedman, however, we’ve know that this fact is to an important degree a sort of statistical illusion. Consumer spending tends to reflect expected income over an extended period.

So that gets us to Milton Friedman.

From the Handbook of consumer finance research, edited by Jing Jian Xiao, this note:

So that gets us to the permanent income hypothesis.

The Friedman reference is to: A theory of the consumption function. Princeton, NJ: Princeton University Press.


Note that the excerpt from the Handbook of consumer finance research is based on "perceived future income"... On expectations. I'm not big on expectations.

Anyway, this is some of what Wikipedia has to say on the Permanent Income Hypothesis:

The permanent income hypothesis (PIH) is a theory of consumption that was developed by the American economist Milton Friedman...

Friedman concluded that the individual will consume a constant proportion of his/her permanent income; and that low income earners have a higher propensity to consume; and high income earners have a higher transitory element to their income and a lower than average propensity to consume.

1. "low income earners have a higher propensity to consume"
2. "high income earners have ... a lower than average propensity to consume"

Sounds to me like it supports the idea of the Marginal Propensity to Consume.

Is Wikipedia pulling my leg?

Interest Income by Quintile

Didn't have to pull too many teeth to find this PDF from the BLS. (Data for 2009.)

Under "sources of income" the PDF includes "Interest, dividends, rental income, other property income" for "All consumer units" and by quintile.

Under "Consumer unit characteristics" the PDF provides the total income before taxes for each quintile.

I took a look at the ratios of those numbers:

Graph #1

Here's the spreadsheet.

Considering interest, dividends, rental income, and other property income as returns to various forms of saving, I am calling the total "interest income" and using it as a proxy to estimate various forms of savings by income quintile. For what it's worth.

McConnell discredited?

Two excerpts from Malcolm R. McConnell's 1975 textbook, and a contradiction I let slide in yesterday's post:

First, from the text above McConnell's Figure 11•2:

Many economists now feel that the MPC and MPS for the economy as a whole are relatively constant. Statistical data such as those of Figure 11•2 are consistent with this position.

In other words, statistical data supports the view that the MPC does NOT change.

Second, from the text below Mcconnell's Figure 11•2:

[The figure] suggests that households spend a larger portion of a small income than they do of a large income.

In other words, statistical data supports the view that the MPC *DOES* change.

Wow. Talk about seeing both sides of an issue!

Gattopardo economics

Via Reddit...

Gattopardo economics: The crisis and the mainstream response of change that keeps things the same

by Thomas I. Palley.

PDF. 30 pages, give or take.

I'm four or five pages in, and I have thoughts for a critique already, but this paper is very good.

MPC discredited?

Steve Roth ponders the Marginal Propensity to Consume (MPC) here:

...since those workers have a high propensity to spend their income, all things being equal that distributional shift should mean there’s ... a virtuous cycle.

and again here:

Sumner, Drum, and Krugman all seem to think that the distribution/MPC/velocity argument has no legs. They’re quite categorical about this.

It is a big deal, because a lot of things fall into place if the MPC idea holds good. If it doesn't hold good, people should be a little more explicit about how it fails than Paul Krugman is:

...that the rich spend too little of their income. This hypothesis has a long history — but it also has well-known theoretical and empirical problems.

If it doesn't hold good, people should be a little more explicit about how it fails than Scott Sumner is (at the first link):

you really need to give up on that MPC stuff, it was discredited decades ago.

The quest for a better explanation of what's wrong with the MPC idea is Roth's focus in comments at the first link (in response to Sumner)...

I’ve poked around a lot looking for a straightforward, cogent refutation (that doesn’t make assumptions that I consider to be questionable). Any leads for me?

... and at the second link, in its entirety. Roth writes:

Can folks (especially those who don’t believe this argument) point me to what might be considered definitive takedowns? I have notions about what they might say, but want to see the best argument(s) out there.

I want to see too, Steve. But I suspect they're a lot like the arguments for free trade:
1. "It's obvious"
2. "We'll get to that later" (and later, they only say "It's obvious"), or
3. something incomprehensible, just to shut us up.


Roth is looking for "the slam-dunk argument that has Krugman and especially Drum convinced that the MPC argument doesn’t hold water".

You know what I like? I like it that even though the MPC explains a lot in a most satisfactory way, Roth is willing to accept that the idea is garbage -- *IF* someone can make the convincing argument. That's the right way to do economics: "always approaching" the best answer.

Anyway, I decided to look through some textbooks for views on the Marginal Propensity to Consume. Maybe that would be the easy way to find the concept discredited, I thought. I went first to McConnell's 1975 edition of Economics:

The proportion, or fraction, of any change in income which is consumed is called the marginal propensity to consume (MPC). Or, alternatively stated, the MPC is the ratio of a change in consumption to the change in income which brought the consumption change about; that is:

This is a bit different from Steve Roth's (admittedly brief) "poorer people spend a larger share of their income/wealth than richer people." And maybe that opens up a door. Because even of the marginal propensity to consume *is* junk, Roth's non-marginal observation may still be true.

In his 1975 textbook McConnell wrote:

Economists are not in complete agreement as to the exact behavior of the MPC and MPS as income increases. For many years it was presumed it was presumed that the MPC declined and the MPS increased. That is, it was felt that a smaller and smaller fraction of increases in income would be consumed and a larger and larger fraction of these increases would be saved. Many economists now feel that the MPC and MPS for the economy as a whole are relatively constant. Statistical data such as those of Figure 11•2 are consistent with this position.

These "feelings" that McConnell describes -- is that all there is?

McConnell's Figure 11•2:

Source: Economics by Campbell R. McConnell (Sixth Edition) Page 229

Reiterating the notes below the figure, a dot would be on the 45-degree line (the black line) if every dollar of disposable income were spent. Where a dot falls below the black line it indicates that some part of disposable income has been saved. The farther the dot falls from the black line, the greater the amount that was saved.

McConnell says the brown line "suggests that households spend a larger portion of a small income than they do of a large income." I agree: The brown line is not a trend-line for the dots. The brown line is a "constant percentage of income" line. For the years since 1946 through 1966 the dots are generally above the brown line. For the years after 1966 the dots are generally below the brown line. At the higher incomes, saving was generally greater than at the lower incomes.

But somehow, that doesn't feel like a slam-dunk argument.

Because too often one reads that the problem of scarcity has been solved

From The mother of invention at Interfluidity:

Actual scarcity has not, in fact, been overcome. We have not achieved overcapacity in aggregate. In a depression, businessmen perceive overcapacity all over the place. But that is a distributional phenomenon. There is an abundance of goods and services relative to the needs and desires of people with purchasing power to consume. There is no such abundance in an absolute sense.

An inverse relation

Via Random Eyes:

 

Pretty interesting: The interest rate and the Federal debt (relative to GDP) move in opposite directions. For a good long period, too: half a century.

It would be a mistake, however, to assume there is a causal relation between these two factors. That would leave out too much. Why do interest rates (blue) continue to rise in the 1970s when the Federal debt (red) is essentially flat? Why do interest rates fall through the 1990s while the Federal debt makes an S turn? There is more to the story than we can see on this graph.

The Reason for Desiring Economic Growth

Checking my blog stats the other day, I noticed that one of the "traffic sources" was a google search for the reason for desiring economic growth is to...

Now, one of the things that's clear in my mind is why we might desire economic growth. So I thought I'd be explicit about it.

Lots of people complain that GDP is not a good number for various reasons. That may be. But it's the number we have. Making the number better is off-topic at the moment.

So what is GDP anyway? It's a measure of what we produce in a year. It's a way to measure the "size" of the economy. And we want it bigger because...

Nope. Not yet.

GDP = Gross Domestic Product
"Gross" = all of it. ("Gross" in this context does NOT mean "yucky".)
"Domestic" = within our country.
"Product" = the stuff we produce.
GDP is a measure of all of the stuff we produce within our country. In a year.

Now I can tell you why it's important. It's important because the total value of what we produce in a year is equal to the total value of our income in a year. GDP = GDI, where the "P" is "Product" and the "I" is "Income".

So, why do we want more economic growth? Because we want more income.

You do want more income, don't you?

BCG81 said...

This is crude. I'm just throwing together a few pictures at FRED, in response to a comment from BCG81 on my old Kaminska and Unit Labor Cost post.

BCG81 said...

I agree it does not make sense to talk about a "correlation" between ULCs and inflation, because they're the same thing. But as I understand it, the reason *nominal* compensation is compared to *real* productivity is to measure the extent to which compensation can rise (as a result of compensation or inflation rising) without putting pressure on prices. You can't see that without holding output prices constant. Also, when using ULCs as a measure of international competitiveness, you want to see both cost (i.e., nominal i.e., labor share) competitiveness and price competitiveness (i.e., relative rates of inflation).

I don't know how to respond in words. The ideas are too big and too nebulous. It goes in interesting but turns to mush in my head. So I went to FRED.

This is crude because I'm just comparing labor cost to corporate profit.


Here's the "Unit Labor Cost" graph I showed in the old post:

Graph 1: Unit Labor Cost

Now if you wanted to compare that to something, you might compare it to Corporate Profit as a share of GDP:

Graph #2: Corporate Profit After Tax as a Percent of GDP

But that's not really a good comparison, for a couple reasons. First of all, the corporate profit measure is "after taxes". Why, I don't know. That's the popular measure though, at FRED. Type corporate profits in their search box and hit enter, and the first thing that comes up is Corporate profits after tax on a list that's sorted by popularity.

Whatever. The second reason...

Well, wait a minute. Let's look at the graphs.The first graph shows unit labor cost going up on a pretty straight path since 1980. That's labor cost, meaning wages and salaries (and benefits) before tax, as opposed to after tax. In addition, the taxes businesses pay on labor are added to that, if I remember right.

The second graph shows corporate profits after tax drifting possibly down until the mid-1980s, then rising from a low of 3% to a current high of over 11%.

From 1980 to the recent data, unit labor cost rose from about 60 index-units to less than 120. I don't know what the index-units are, but I can see that unit labor cost did not quite double since 1980. By contrast, corporate profits increased from 3% to over 11%. That's almost a fourfold increase, in less time than it took for the unit labor cost to double. Now... where was I?

The second reason these two graphs are not a good comparison is that Graph #2 shows profit as a percent of actual-price GDP. To make it comparable to Graph #1, we'd have to show it as a percent of inflation-adjusted GDP, like this:

Graph #3: Corporate Profits After Tax as a Percent of Real GDP

Now that sucker's going up.


I downloaded the data from Graph #3 and figured the average of the four (quarterly) values from 2005. That value is 9.72447382422837. (You should be laughing because I'm using all the digits.)

I used the average to create a version of Graph #3 that shows the data as an index with 2005 = 100, just like the Unit Labor Cost in Graph #1.

Here's the corporate profit data in blue, and the Unit Labor Cost data in red:

Graph #4: Unit Labor Cost (red) and Unit Corporate Cost (blue)

Here's the same data, just since 1980:

Graph #5: Unit Labor Cost (red) and Unit Corporate Cost (blue) since 1980

So, what's going up faster? What's driving prices up? Labor cost, they say. Not the blue one, they say. Well, maybe that was true in the Reagan years...


But, you know, maybe that's not so clear. Both lines are going up since the latter '80s. Let me do what I did in the old post, and show the data relative to "nominal" GDP -- GDP measured in the prices we actually paid to buy the stuff we bought:

Labor Cost (red) and Corporate Profit (blue) Indexes Relative to Actual GDP

Yeah, that red one? The one that's going down since 1960? That's the one they say makes prices go up.

It can't be true.


And now I can respond to BCG81:

I don't know about the things you said. But I know that any time you divide "nominal" something by "real" something, you are factoring inflation into the result.

And I know that after you factor inflation into something, the thing looks more like inflation than it did before.

And I know economists like to take these things with inflation factored in, and compare them to inflation, and say Wow, look at the similarity.

And I know that the similarity is created by the arithmetic. Not by the economy.