Wednesday, June 30, 2010

Whose is Bigger?

My conservative pal R at work came into my office the other morning to tell me there's a new website that lists New York State employees and how much they make. It was "unsettling" he said, to find out that some DPW guys he knows make $70k-plus. "No wonder the state's going broke," he said.

But R's well-paid friends are not the problem. Slow growth is the problem.

Question: What does slow growth mean? It means slow growth in the private sector. That's the problem. That's what bothers people. Nobody thinks it is "growth" when it's the public sector that's expanding. "Growth" means growth in the private sector.

The problem is slow growth in the private sector. That means guys like my buddy R and me don't get the sort of pay raises we'd get in a better economy. We fall behind.

By contrast, public-sector workers are riding a wave that has slowed less. But that isn't excessive growth. It's normal. Less than normal. It only looks excessive because the private sector is so far behind. And I think we're starting to get jealous.

Private-sector workers are starting to blame public-sector workers for the widening gap. This is dangerous. Troubling, and personal, and dangerous. My buddy R seems to think a problem can be solved by cutting the pay of public-sector workers. But that only solves the jealousy problem. It doesn't solve the growth problem.

In simplest terms, the problem is a shrinking private sector. People see that private sector growth is lousy and public sector growth is less bad. They somehow conclude from this, that the public sector is growing too fast.

Lousy growth is the problem. But making sure that everybody has lousy growth is not a good solution.

Tuesday, June 29, 2010

The Factor-Cost of Money

I wrote to Milton Friedman back around 1980, calling the interest rate "the price of money." He wrote back -- he must have answered every letter he ever got -- to say that the interest rate is the price of credit. And he said the price of money is whatever you give up to get it.

I was fine with those corrections for 30 years. Recently, though, I had a thought.

To Friedman's two definitions, the price of credit and the price of money, one must add a third: the cost of money.

The total accumulated cost of interest paid in our economy is the factor cost of money. I'm not saying it's good or bad. I'm simply defining terms. Because if we don't define 'em, we cannot properly analyze the economic problem.

Monday, June 28, 2010

Following up...

...on the title of a Recent Post

Pretty much everyone is aware that the Great Depression was followed by World War II. After the war we had about 30 years of Keynesian economics and then 30 years of Reaganomics.

What I didn't know is that there were different names for different stages of that 60-year postwar stretch. Here are the names I've turned up:

I don't have much to say about these, except that the "golden age" was a brief 15± year period that perhaps should be called The Golden Moment.

What I think, though, is that the 4-point list, above, actually misses the main thrust of the past 60 years. Those 6 decades need not be broken down into four phases, nor even two, but only one long stretch with a name that captures the essential character of the period: The Great Indebtedness.

Sunday, June 27, 2010

The Indebtedness

The great burden of debt in the world today -- in the U.S. and in nations that modeled their economic policy on ours -- is the result of U.S. economic policy.

A simple change is all that is needed to correct the policy: We must encourage the accelerated repayment of debt.

Unfortunately, we waited too long. We had the financial crisis, our Paulson moment, and then the economy started to fix the problem by itself. Everybody and his brother scramble to get out of debt.

One word comes to mind: disarray.

The new policy will help: Accelerated repayment of debt will help. It will ease cost burdens a bit, and it will create confidence that government is finally doing the right thing: Helping us do what everyone is already trying to do.

So we get the debt reduced a little faster this way, because of the coordination of effort. And the Second Great Depression lasts 8 years maybe, instead of ten.

Not good enough.

Almost everybody says the economy won't recover until we get the debt paid down a lot. And everybody is doing what they can. And the new policy will help. But we need to do better, faster. The longer we wait, the harder it is to recover.

As a temporary fix for the cyclical problem, I propose direct action. Let the Federal Reserve print another trillion dollars. Only don't let them use it to buy up bad debt from the banks. Instead, let them use it to pay off debt for people. Direct action.

A trillion dollars of debt goes away, painless and quick. The money goes into the banks, not into the spending stream where it may cause inflation. And, well, borrowing creates money, and paying off debt destroys money, so the trillion dollars vanishes.

Actually, a trillion dollars of credit-in-use becomes a trillion dollars of available credit again. Our savings, in the banks, ready to lend. Ready to create growth or inflation.

But with enough debt destroyed, new spending will create growth. The reduction of private-sector debt is the key to our next golden age.

Saturday, June 26, 2010

The Great Indebtedness

It is often said that our great indebtedness is the result of excessive spending, public and private. Arthurian economics denies that. The source of our great indebtedness is bad policy -- a policy that limits the growth of money, encourages the use of credit, allows and rewards the accumulation of debt.

The purpose of policy is to change economic conditions. Existing policy has changed economic conditions by creating a monetary imbalance. The solution to our economic problem is to change the bad policy. The solution is to improve policy by rewarding the accelerated repayment of debt. Little else need be done.

Tax policy to encourage the accelerated repayment of debt would induce consumers and businesses to make a few extra payments on existing debt, rather than spending those dollars at the mall, say, or on new business software. It would draw money out of circulation; it would return money to the banks; it would retire debt.

Drawing money out of circulation, it would serve as an inflation-fighting policy. It would serve the purpose that Federal Reserve policy serves at present. The Fed, of course, can remove money from circulation. But it cannot reduce your debt. The new Arthurian policy would fight inflation by reducing your debt.

Accelerated repayment of debt strikes at the source of money-creation and solves the problem simply, by encouraging the completion of credit transactions. Note that the economy is moving in this direction on its own, anyway. This is a sign of what needs to be done and what is the right thing to do.

Accelerated repayment of debt would free up the Fed to increase the growth of money. New Arthurian policy would not only permit that, but would make it a clear necessity. Repayment of debt draws down demand -- as we well know from the experience of the past two years -- and is deflationary. To counteract these downward pressures the Fed would find itself required not only to increase the quantity of money, but also to make more credit available at lower rates.

But the Fed's response would not be inflationary. It would simply counteract the deflationary pressures from the accelerated repayment of debt.

The goal of policy must be to reduce the level of existing debt while encouraging new uses of credit. That is not a zero-sum change. By discouraging the accumulation of existing debt, Arthurian policy reduces the debt burden and fights inflation. By encouraging new uses of credit, the policy encourages demand and growth.

Friday, June 25, 2010


As the two previous posts show:

  • Over the past 6 decades, corporate interest costs increased by more than 7% of corporate costs. Corporate employee compensation fell by almost as much.
  • Corporate interest costs are now 60% as much as wage and salary costs.
  • If corporate interest costs could be cut in half, enough money would be freed up to increase all corporate wages and salaries, and compensation of officers, by 30%

All we'd have to do is cut corporate interest costs in half. And the easy way to do that would be to cut the use of credit by half.


But we need credit for growth, you say.

Well, yeah we do. I agree absolutely. We need credit for growth. But we should not be using credit to maintain the existing level of economic activity. There should be money enough in circulation to support the existing economy. Credit is for growth.

But that is not how we do things today. And that is the problem.

For years and years, the Federal Reserve restricted the growth of money to fight inflation. But to encourage growth, Congress encouraged the use of credit if money wasn't available. Congress and the Fed together created a shortage of money and an excess of credit use. They created an imbalance in our monetary system.

Today we use credit even for normal day-to-day expenses, like buying food and gasoline, because of this monetary imbalance. Because of this monetary imbalance.

As things stand now, money is in short supply and we use credit for everything. But credit is also in short supply, because the source of credit -- money -- is restricted, and because we continue to rely excessively on credit.

Congress therefore finds it necessary to coerce source-fund availability by establishing savings systems with punishment for early withdrawal: Bizarre policy, on the face of it.

And because we rely excessively on credit, our economy is vulnerable to credit crunch and financial crisis.

And because we rely excessively on credit, we have a phenomenal, inexplicable, insurmountable, unbelievable, dangerous, troublesome debt.

And because we rely excessively on credit, there are excessive interest expenses all through the economy.

The shortage of available credit, the pro-credit policies of Congress, the vulnerability to credit crises, excessive debt, and the inflation associated with rising costs all stand as evidence of our excessive reliance on credit.

Our excessive interest expenses are "extra" in the sense that there is no need for them. Excessive interest costs are the result of relying too much on credit, and too little on interest-free money. They are are the result of monetary imbalance. And monetary imbalance is the result of bad policy.

The increase in corporate interest costs and the commensurate decline in corporate employee compensation are results of a very bad policy.

Thursday, June 24, 2010

Components of Corporate Cost

The previous post looked at "wages and salaries" plus "compensation of officers." But I could find those numbers for only a few years. So the previous graph gives no feel for changes that have taken place over the years.

This graph rectifies that by using "employee compensation" numbers. Now we can see 60-year trends. But these numbers are substantially higher. (I suppose they include health benefits and such.) So we're not talking 12% anymore.

Here we see "employee compensation" fall from 24.56% in 1948 to 18.34% in 2007, a decline of more than 6 percentage points. Over the same period, corporate interest costs climb from less than 1% of deductions in 1948 to 8.6% in 2007. That's an increase of more than 7.5% percentage points, 7½% of corporate costs.

The post-war trends show that corporate interest costs increased and employee compensation fell. But what happened with corporate spending is only part of the problem of rising interest cost in business, in government, and in our personal lives.

This is only a ballpark number, but if we take corporate deductions for 2007 ($26.97 trillion) and reduce interest costs enough to boost employee compensation from 18.34% to 24.56% like it was in 1948, employee compensation increases from $4.9 trillion to $6.6 trillion. That's an increase of more than one-third, in your paycheck and mine.

And it doesn't increase corporate costs a penny.

Wednesday, June 23, 2010

Parsing the Question (Part 2)

Let no one any longer labor under the false assumption that wages and salaries make up anything like 65% of business expenses. The number is less than 12%.

This does not mean that a substantial increase in labor cost would have a negligible effect on prices. What it does mean is that, if we want an explanation of the costs that drive prices up, there's more to look at than just the cost of labor.

In 2006 (to bring numbers forward from my previous post) deductions for corporate expenses came to $25.5 trillion. Of that, labor amounted to less than $3 trillion, about 12% of cost. ("Labor" here includes salaries, wages, and compensation of officers.)

As long as our focus is only the cost of labor, there is a very big cost number that remains unexamined: 88% of 25.5 trillion, some $22 trillion plus.

Included in that 88% is the interest expense associated with corporate business activity. Interest expense, as you may know, is the focus and concern of Arthurian economics.

The 2006 numbers show that corporate interest expenses amounted to nearly $1.8 trillion. That's more than 60% of the total of wages, salaries, and compensation of officers combined. If we cut interest costs in half, everybody could get a 30% raise and it would not increase corporate costs by even a penny.

Tuesday, June 22, 2010

Parsing The Inflation Question

The opening words of The Inflation Question (PDF) caught my attention:

The single most important factor determining U.S. inflation is employee compensation. Compensation accounts for about 65% of national income—a rise in compensation increases disposable income thus stoking demand in the economy. However, and more importantly from an inflation perspective, higher compensation boosts labor costs, forcing firms to raise their prices to maintain profit margins.

There are at least two reasons I like that statement:

1. I like their choice of words here: Compensation accounts for about 65% of national income. They refer to a percentage of national income, not a percentage of national economic activity. National Income is a technical term, well-defined and specific. National Economic Activity, apart from my own definition of it as "spending," is non-technical and to my knowledge undefined and uncounted.

2. I like their explanation of inflation. They consider both sides of the supply and demand equation: Rising compensation boosts demand, they say, but "more importantly from an inflation perspective, higher compensation boosts labor costs, forcing firms to raise their prices to maintain profit margins." They consider both demand-pull and cost-push inflation, and they say the cost-push forces are more significant.

I like that because, in my view also, our inflation has been cost-push for some time. Idunno, maybe J.P.Morgan and the report's author, Dr. David Kelly, are supply-siders concerned only about business conditions and not at all about customers' conditions. I see no evidence of that, but I don't care if they are. They agree with me that inflation is a cost-push problem. Good work, guys.

There are also two reasons I don't care for that opening statement:

1. It sounds like there is absolutely nothing that can be done to improve the standard of living: Any increase in payroll will cause a price increase. Of course, we know better. For if living standards can fall -- and we know that can happen -- then they can change; and if they can change, they they can rise. But you don't get that from the excerpt.

2. It is deceptive to say "Compensation accounts for about 65% of national income," and follow that with "higher compensation boosts labor costs." They make it sound like employee compensation is 65% of business cost. That's not even close.

They describe compensation as part of income. And clearly it is; but income is not the same as cost.

(After a long delay...) Here we go. The most recent corporate tax data I could find is from 2006. I found the link at Paul Caron's TaxProf Blog. (NOTE: Clicking on his "2006 Corporate Tax Returns" link starts the download of a 6½ meg PDF. Clicking on the graphic at right gives you the relevant bit of it.) On page 83 of that PDF, the two left-most columns give a nice breakdown of corporate numbers for 2006.

Halfway down that page we find total [corporate] receipts. A few lines down from that we find total deductions. Total deductions -- basically, everything bookkeepers had receipts for, and corporations paid no tax on -- added up to $25.5 trillion for 2006.

In the breakdown of costs under "total deductions" we see that compensation of officers cost more than $473 billion, or about $0.473 trillion. Salaries and wages came to $2.457 trillion. Added together, salaries, wages, and compensation of officers amounted to a bit under $3 trillion.

So, all the spending corporations did that year, or all they could legally deduct anyway, came to $25.5 trillion. All the money paid to employees came to a little under $3 trillion, or less than 12% of total costs. Not 65%. Twelve percent.

So basically, if everybody in the company got a 100% raise, that would increase costs by 12%.

But that's not a realistic raise.

Say you work for an "average" corporation where employee compensation amounts to 12% of expenses. Here: You work for SmallCorp, with total deductions of $100. Labor costs: $12. Now everybody gets a 10% raise. What happens to the numbers?

Labor costs go up $1.20, to a total of $13.20. Total costs also increase by $1.20, to $101.20. So a 10-percent pay increase translates to only a 1.2% cost increase for SmallCorp.

Of course, SmallCorp has to pass along that 1.2% increase to its customers, plus a little something for itself. So those customers see a cost increase in addition to any across-the-board pay hike of their own. And the customers' customers see somewhat greater cost increases. By the time every working stiff in the country gets that 10% raise, and those costs have worked their way through the system, we'd see a substantial jump in prices, no doubt.

My point nevertheless remains valid: Employee compensation is far less than 65% of business costs.

Monday, June 21, 2010

A Photocopy in my Files

Sunday, June 20, 2010

There's Gold In The Mountains

This graph is a little faded, perhaps. But it is a key piece of the Arthurian puzzle. The graph shows the balance (or imbalance) between money in circulation, and savings.

The graph shows that the quantity of money in savings increased much faster than did the money that was circulating until there was about 80 cents in savings for every circulating dollar, and the Great Depression hit. Then the money in savings decreased relative to money in circulation, right up to the end of World War II.

Then the trend changed again, savings started growing faster, and we had our golden age. But by 1969, the last date shown on the graph, the quantity of money in savings had risen again and was climbing off the chart. And our little golden age soon ended.

Yeah, I didn't believe it myself. So I checked my numbers.

Year M1 M2 (M2-M1) (M2-M1)/M1
1915 12.48 17.59 5.11 $0.41
1930 25.76 45.73 19.97 $0.78
1945 99.23 126.63 27.4 $0.28
1969 201.77 385.17 183.4 $0.91
1970 209.98 401.29 191.31 $0.91
2008 1596 8154 6558 $4.11

The last column on the right has numbers comparable to what's shown on the graph.

The last row of data, the data for 2008, shows that the quantity of money in savings kept growing much, much faster than the quantity in circulation, and that by 2008 we had more than four dollars in savings for every circulating dollar.

Now, that's an imbalance.

The lesson for me in this graph, back in 1992, was that the imbalance between savings and circulating money reached a peak at the onset of a Great Depression, and that correction of the imbalance (as it happens, by means of an enduring slump followed by war, though there are better ways) was necessary to restore a healthy economy.

Growth is accompanied by the uptrend on this graph; but the uptrend eventually chokes off growth. Downtrend is necessary for recovery. And then renewed uptrend accompanies reinvigorated growth.

The lesson for policy in this graph is to choose a range on the graph, a range that is well-suited to "golden age" growth; and to create incentives and disincentives that keep the monetary balance in that golden range.

The data for M1 and M2 values are from series X 414 and X 415 of the Historical Statistics, Colonial Times to 1970, Part 2, Section X, for all data except 2008. Values for 2008 are from Table 1159 of the Statistical Abstract, 2010, Section 25.

Both are available online and free from the U.S. Census Bureau.

Saturday, June 19, 2010

From the Archives...

Generated by a C-language program I wrote way back when. Printed on a dot-matrix printer; the dots are visible if you zoom in.

Match up the dates: This graph looks like the Tax Policy Center graph from the previous post.

Friday, June 18, 2010

The Long Decline

Definitely an aspect of the long decline, though perhaps not one we might expect, this graph (showing a history of the corporate income tax) is from the Tax Policy Center (Urban Institute and Brookings Institution):

Corporate income taxes declined relative to GDP from the early 1950s to the early 1980s -- the Keynesian period of the postwar world. Then during the next thirty years, the thirty years of Reaganomics, corporate taxes declined no more, but were stable. Who'da thunk it?

The graph shows a kink, a trend change, at about the same time as the two graphs in my recent post on the Keynes/Reagan Shift. I was gonna let that go. I wasn't gonna show the graph, but then I happened upon this...

This paper replies to Michel Husson’s (2009a; also Husson 2010) critique of my study of movements in the rates of profit of U.S. corporations (Kliman 2009). I showed that rates of profit fell markedly, beginning in the late 1950s and continuing through the early 1980s, and that no sustainable rebound in profitability took place between the trough year of 1982 and the trough year of 2001.

...from the PDF Masters of Words, by Andrew Kliman.

The corporate income tax is a tax on profit. The graph shows that corporate taxes followed a path very similar to the path of corporate profits as described by Kliman. Kliman's PDF goes on to say "this persistent fall in profitability is an underlying cause of the latest economic crisis, since it led to ... mounting debt problems."

I don't buy that. I have my own ideas about the origins of our debt problems. But Kliman's description of what happened to corporate profits matches up remarkably well with the graph, above. There's just something very satisfying, when things match up that well.

Thursday, June 17, 2010

The Long Decline

A graph from Bill Conerly's Businomics Blog:

(From his April 25, 2009 post.) Look at the downhill trend created by the peak points. Capacity utilization at its best has been getting worse. Evidently the Keynes/Reagan shift (see my previous post, below) did nothing to slow the Long Decline.

With this picture I start a collection of graphs showing the long decline. But this one has a special relevance. A while back I quoted Anna Schwartz on the cause of inflation:

An increase in the supply of money ... stimulat[es] spending. Business firms respond to increased sales... The spread of business activity increases... In a buoyant economy, stock market prices rise... If the money supply continues to expand, prices begin to rise, especially if output growth reaches capacity limits.

"Prices begin to rise, especially if output growth reaches capacity limits."

Looks like those limits are getting lower. My comments from that post:

If it is true (as has been stated repeatedly) that our money supply has increased, then where is "the spread of business activity"? Where is "the demand for labor"? Where is "the demand for capital goods"? Where is the approach to "capacity limits"? Where is the "buoyant economy"? And why do we have all this debt?

What Schwartz describes is the "demand-pull" version of inflation -- a version we've not seen since the rise of stagflation in the very early 1970s. Her famous book with Milton Friedman was published in 1963. At that time, the economy was buoyant. It is buoyant no more. Her explanation is defunct.

Live long and prosper.

Wednesday, June 16, 2010

The Keynes/Reagan Shift

Recently I showed Emmanuel Saez's graph (above) and pointed out the policy change that occurred right around 1978. I called it a policy change from Keynesian economics to Reaganomics. The change actually started before Reagan became president, but people generally associate the changes with his name.

For the record, the change also occurred 30-odd years after the death of Keynes. So the use of both names is something of a metaphor. But names are the least important aspect of this; it's the change itself that is significant.

Here's a short list of changes from Paul Krugman for what it's worth:

  • slashing taxes on the rich
  • breaking the unions
  • letting inflation erode the minimum wage

Here's an excerpt from The Agonist that chops up history the same way I do:

MMT is a macroeconomic theory which tries to explain the operation, structure, and behavior of national economies (as all macroeconomic theories do). This puts it in the same league as Keynesianism and Monetarism.... Roughly speaking, US economic policy from the New Deal until the early 1980s was mostly Keynesian, while policy from the early 1980s until today has been roughly Monetarist.

I like this guy. He's looking at the same policy-shift I am, and his dates and time-spans are close to mine. The Agonist calls it a shift from Keynes to Monetarism, I call it Keynes/Reagan. There's a lot more to what's been happening for the last 30 years than just Monetarism, in my view. But we're in the same ballpark. The labels are of little importance, and the dates are close.

Finally, here is a little more evidence, another graph that shows a change that occurred around that time:

Chart 1 here is from a PDF titled The Inflation Question, a "Market Insights" report from J.P.Morgan Asset Management.

Tuesday, June 15, 2010

Modern Monetary What??

My friend K is in love. He sent me a link to a post on Modern Monetary Theory, something about "nine myths about the deficit." I couldn't read it. I got maybe two paragraphs in. It was all wishes and bad argument. Sheesh! Don't people know that bad argument is bad? But my friend is in love. So I said I'd take another crack at it.

I googled the phrase modern monetary theory mmt. Got a screenful of results. Here, check 'em out:

1. Modern Monetary Theory, MMT, and The Full Employment Theory ...
Posted by politicalpartypooper on May 10, 2010

Modern Monetary Theory (MMT). Chartalism.


The theory is based on the idea that it is governments that create money instead of people’s goods, skills, and services.

In such a system, fiat money is created by government spending and then taxation is employed to reclaim the money...

ENOUGH. First of all, it is government that creates money. "People’s goods, skills, and services" is output, and skills, and output. Neither output not skill is money. Neither creates money. Money is the stuff that's generally accepted in exchange for goods and skills and services. But the money thus exchanged is already existing -- existing, that is, unless it's just been newly created by the government.

How did this guy get to be first in the search results??? Off with his head.

2. MMT (Modern Monetary Theory), the budget, and unemployment policy ...
Mon, 04/26/2010 - 9:36pm — lambert

One of the perspectives of the MMT way of thinking about budgeting is that in the United States the dollar is public money, since in a state whose currency is sovereign (like ours, but unlike the EU countries), money is created by the state (Article I, Section 8). Since the state exists to "promote the general Welfare" (preamble), and not to provide the banksters with the lifestyle to which they have become accustomed, why not use the state's money for the public purpose of ensuring full -- 100% -- employment?

The banksters?? And why is this guy explaining state-sovereign-currency? The EU nations are like the "states" in our "United States." Our states don't have their own money, either. Isn't it obvious? But this is all irrelevant.

Q: Why not use the state's money to put everyone to work?

A: Because of the consequences: the value of the dollar, inflation and all that. Perhaps Number Two here could make a good argument that prices wouldn't go thru the roof. But I'm not waitin' to see if he gets around to it.

3. Give The People What They'll Like, Already: Not “Stupid Hooverism ...
Tue, 01/26/2010 - 2:43am — letsgetitdone

For the Democrats in Congress, winning in November isn't rocket science; it's about having the will to pursue survival ruthlessly.

STOP. We're trying to think about an economic harrumph here, modern monetary harrumph. So how come the topic is I Hope My Party Wins ?

4. billy blog » Blog Archive » A modern monetary theory lullaby
In recent comments on my blog concern was expressed about continuous deficits. I consider these concerns reflect a misunderstanding of the role deficits play in a modern monetary system. Specifically, it still appears that the absolute size of the deficit is some indicator of good and bad ...

I should note at the outset that these simple teaching models are only designed to reinforce the stock-flow relations at the sectoral level and show the inevitable relationships that follow from the national accounts when discretionary action is taken by, say, the government to cut back its deficit.

STOP. This guy has potential, if I have the patience to disentangle phrases like "these simple teaching models are only designed to reinforce the stock-flow relations at the sectoral level and show the inevitable relationships that follow."

Maybe tomorrow.

5. 3spoken: A primer on Modern Monetary Theory (MMT)
Friday, 16 April 2010
Modern Monetary Theory (MMT) is an attempt to explain how 'money' comes about in a way that is different to classical economic theory. If true it shows that the way the government runs the financial part of the economy is inefficient and that we actually have much more flexibility to get us out of the current recession than we are using. Scary stuff.

Oh I like it... except he uses different to where I would use different from. Other than that, this one's not bad. Lots of links to look at, too.

6. Links on Modern Monetary Theory (MMT) « EconProph
March 20, 2010
Filed under: Banking & Money — Jim Luke @ 11:51 am

Hyperinflation is not just more inflation. Additional conditions are needed to go from inflation to hyperinflation.

Wrong focus.

7. Modern Monetary Theory - An Overview | The Agonist
In my recent travels around the internet, I happened across the blogs of Bill Mitchell and Warren Mosler, which discuss Modern Monetary Theory (MMT). MMT is a macroeconomic theory which tries to explain the operation, structure, and behavior of national economies (as all macroeconomic theories do). This puts it in the same league as Keynesianism and Monetarism...

But MMT has fascinated me, because it claims both of these schools of thought are fundamentally in error. If its proponents are correct, then the way that we currently think about the national economy is very wrong, often backwards, and extremely harmful to our own well-being. We have been systematically under-investing in the economy and in our human capital since at least the 1970s. Why do I say the 1970s? Because that’s when we switched from the gold standard to a fiat currency, and that switch subtly changed the nature of our government’s relationship to the economy.

Enough. This isn't bad, actually. But I gave him a lot of space here, and all we got is teaser. He's got the melody, but not the words.

8. Modern Monetary Theory (mmt) group - The Mule Stable

Full name
Modern Monetary Theory

Looking at the macroeconomic implications of fiat money. AKA chartalism, money mechanics or dynamics.

chartalism mmd mmm

This is "a user group" where "members share short messages." Mmm.

9. Modern Monetary Theory: Market Discipline for Fiscal Imprudence ...
May 18, 2010
Let’s talk about bond market vigilantes and the term structure of interest rates in a fiat currency system. That’s a mouthful, but I’ll explain what I mean.

Bootstrapping the yield curve

When I was in business school, we learned about bootstrapping the yield curve. Basically, long-term interest rates can be expressed as a series of short-term interest rates, such that if you know long-term rates, you can calculate expected future short-term interest rates. This is important because it tells you what people believe the Federal Reserve is likely to do with interest rates in the future.

For example, say you know the 5-year rate by looking at the current on-the-run 5-year interest rate on Bloomberg. Then, all you need to calculate all the expected future expected 3-month rates are quotes on U.S. zero-coupon bonds known as Treasury STRIPS. They are quoted in the Wall Street Journal daily.

Nah, I don't have the time for this. Sorry, Nine.

10. Tenets of Modern Monetary Theory/Post Keynesianism - Economics ...
For those of you who overlook announcements, please accept our invitation to this year's party at ARIA. Click here for details

Yeh, okay.


Well, that's the top ten of 34,200 hits returned by Google. Enough, I think. So what did you learn about Modern Monetary Theory? Not so much?

Me too.

Monday, June 14, 2010

An Idea Whose Time Has Not Yet Come

There is a concept I cannot accept. Some people say: The quantity of money must get larger every year because the population grows, and the economy grows. That's fine. But then they add: So the government should just print that extra money and spend it.

Actually, it's not a bad idea. But it makes our money seem fake, like Monopoly money. Let me be first to admit, our present system is no more or less fake. But the present system is much more convoluted and confusing, so the money doesn't seem so fake.

This plays to the "confidence" and "trust" aspects of our economy.

There was an article in Parade not long ago about the Value-Added Tax, the VAT. (See my post of 5-31-2010.) The article said: "some policy experts worry that a VAT could actually raise so much money—and so easily—that it would encourage Congressional waste. 'A VAT would take the pressure off the government to rein in spending,' says Rudolph Penner..."

Now, I'm not sure what it means to raise money "easily" by taxation. But I'm sure it would be "easy" to raise money by printing it. And it would lead to Penner's problem: It would take the pressure off government to rein in spending.

The mathematical reason I cannot accept print and spend as a workable plan is that Federal deficits tend to be bigger than the increase in money justified by growth. Printing enough money to cover the deficit would therefore be inflationary in the old-fashioned sense of the word.

Between 1950 and 2008 the Federal debt increased by about $9.75 trillion. In 2008, M2 money totaled about $8.15 trillion. And M1 money, the better measure, totaled only about $1.6 trillion. Printing money to cover deficits would therefore have led to a great increase in the quantity of money. That is, inflation in the old-fashioned sense of the word.

Interestingly, it may be that after the economic problem is solved, the deficits will be small enough that printing money could cover them and more, and still not be inflationary. At that point, the notion comes into its own and I accept the concept. (In a healthy economy, people wouldn't be so worried about money being "fake.") But unless and until we can run our economy right, printing money to cover deficits will only make matters worse.

Sunday, June 13, 2010

Something Else from Eric deCarbonnel

A picture's worth a thousand words: I like graphs. Anyway, here's a long-term view from deCarbonel's Market Skeptics blog:

This picture, this visual history of America, is on deCarbonnel's under the heading Monetary Policy, theme of Gold Policy. And sure enough, it shows a long-term close relation between the value of gold and the value of the dollar. Except during the Civil War, and except since 1934.

But I'm showing you that picture for a different reason. Look at the low points on the graph. There's one just before 1820. One during the Civil War. One around 1920. And one... Let's say 1980 (when gold reaches a really high peak) after which the dollar stops losing value really really fast.

Arbitrary? Not entirely.

Now, compare those four key points to the Kondratieff graph here.

The end of Kondratieff "Summer" occurs in 1816, 1864, 1920, and 1980. It's a good match to the low points on deCarbonnel's graph.

After the fact? Maybe. Interesting? I think so. But it's not coincidence. Both graphs show price trends. We should expect them to match up. What's interesting is the repeating wave pattern, the regular ups and downs clearly visible until Depression-era policies disturbed the waters.

The old rhythm no longer shows up on the graph. But that doesn't mean there is no rhythm. It only means we don't know how to read the evidence.

Saturday, June 12, 2010

Surely he would tell us

A follow-up to my "Credit Efficiency" post... which I said that if Paul Krugman knew why the high level of debt after World War II turned out not to be a problem, he would tell us.

Krugman confronts problems by presenting other problems, stirring up a little confusion, and saying the other guy is wrong. It is entertaining, but it doesn't solve the problems.

But Krugman is not the only one who doesn't know how to solve economic problems. Hafer and Wheelock don't know, either. Their approach is to claim that monetary policy doesn't work, except maybe in the short term.

Other economists claim that fiscal policy doesn't work. But that's all we have, you know, monetary and fiscal policy. If economists can't make them work, they should go into some other line of work.

These guys are plain out of ideas.

Friday, June 11, 2010


Paul Krugman is very good with words. That probably accounts for the intensity of opinion about him, both for and against. But sometimes he's too good with words, and that allows him to change the subject and avoid answering important questions.

Here's Krugman from 24 May:

Did The Postwar System Fail?

I’ve been posting about the contrast between the popular perception on the right that America had slow growth until Reagan came along, and the reality that we did fine pre-Reagan, in fact better; see here, here, and here. And what I’m getting as a common response — including from liberals — is something along the lines of, “That’s all very well, but by 1980 the postwar system was clearly failing, so what would you have done instead of Reaganomics?”

Which all goes to show just how thoroughly almost everyone has been indoctrinated by the current orthodoxy.

Krugman takes the "common response," phrases it better than anyone else, and then proceeds to ignore the question.

You cannot ignore the question, Krugman. It is the most important question since Keynesianism fell into disarray. Here's PK's answer:

Here’s what I think: inflation did have to be brought down — and Paul Volcker, not Reagan, did what was necessary. But the rest — slashing taxes on the rich, breaking the unions, letting inflation erode the minimum wage — wasn’t necessary at all. We could have gone on with a more progressive tax system, a stronger labor movement, and so on.

... Radical change happened because a powerful political movement wanted it, not out of economic necessity.

Radical change happened because Reagan's people had ideas and Krugman's people didn't.

So Krugman says we needed tight money to break the upward spiral of prices. He offers nothing else. But by 1980 the postwar system was clearly failing, Paul. And you would have done nothing about it.

Thursday, June 10, 2010

The Missing Link

So I'm driving to work, thinking about this morning's post. Two points I made. First: Inflation isn't caused by printing money. Second: Without all that printing-of-money we'd be in deflation now.

Don't these two points conflict? I think they do. If inflation is not caused by printing money, then deflation is not caused by not-printing money. I'm guilty of the same error I find unacceptable in others.

So let me restate Point #2: Without that massive injection of emergency money, the decline in spending would have led to decisive deflation.

Policymakers use "printing money" as a way to encourage spending. They print money or hold it back to influence spending one way or the other, in order to restrain inflation or stimulate growth.

But it is a two-stage process: Printing money influences spending, and then spending influences prices. To say "printing money causes inflation" is a shortcut, the same way it was a shortcut when I said in the earlier post that failing to print money would have caused deflation. It's generally true, but that's because the money affects spending, and spending affects prices.

Some people seem to take these shortcuts a little too literally. They seem to think it's the printing that causes inflation, when really it's the spending. This misunderstanding creates a lot of unnecessary disagreement. And it impedes achievement of a solution to the economic problem.

The purpose of printing (or not printing) money is to influence prices. But there is no direct link between money and prices. Money and prices both link to spending.

Why is it important to distinguish the two separate stages? Because spenders have free will. Spenders make their own decisions. The government didn't force us to spend an extra trillion or two; they only gave us the chance to do so. Economic policy, when it is good, only induces; it never forces anyone's hand. That's why our policy manipulates the money supply and why it doesn't just administer prices.

The emergency-money printed by policymakers turned out to be barely enough to keep spending in a Neverland where we cannot tell if prices are going up or down.
But if they didn't print it, the fall in spending would surely have caused deflation.

Two Points

From the first Mises Daily I ever read:

Mish Should Ditch His Deflation Fears

Mike Shedlock, a.k.a. 'Mish'
Mises Daily: Monday, July 13, 2009
by Robert P. Murphy

We who are advocates of sound, free-market money need to get our story straight. Are we predicting hyperinflation or massive deflation? Personally, I am much more worried about the former problem. Using a recent article by Mish, I hope to show that no one has made a convincing case for falling prices.

Fair enough, story straight. Mish is predicting deflation; Robert P. Murphy is predicting hyperinflation. What to think.... What to think?

Bob Murphy's post is near a year old, and the inflation-versus-deflation question is not yet resolved.

It is some 15 months now since the Fed's trillion-dollar Quantitative Easing event, and the inflation-deflation question is not yet resolved.

It is more than 470 days since the $787 billion stimulus package was signed into law, and the inflation-deflation question is not yet resolved.

It is approaching two years since the TARP was announced, and the inflation-deflation question is not yet resolved.

What to think? I think printing money doesn't cause inflation.

Now wait a minute, you might say. We've been waiting, I reply.

"We'll get the inflation," you say. "We'll get it when the economy recovers. We'll get it when spending picks up again."

And oh, you are right about that. It is the spending that causes inflation, not the printing. Right you are.

Point #1: Inflation is caused by spending, not by printing money.

Item #2: The inflation-deflation question is still unresolved. After all that TARP money, and all that stimulus money, and all that Quantitative Easing money, we still cannot see decisively whether the economy is tipping toward inflation or deflation.

Now, imagine how things would have gone without all that emergency money.

Point #2: Without that money, we would have seen decisive deflation.

UPDATE: Please refer to my follow-up post, The Missing Link. -- Art

Wednesday, June 9, 2010

The Long and Short of It

I don't remember where I found this PDF --

The Rise and Fall of a Policy Rule: Monetarism at the St. Louis Fed, 1968-1986
R.W. Hafer and David C. Wheelock

(Across the top of the page it says FEDERAL RESERVE BANK OF ST. LOUIS, and on the opposite page REVIEW, and at the bottom it says JANUARY/FEBRUARY 2001.)

But anyway, here is the first part of the opening paragraph:
Macroeconomists today generally agree that monetary policy cannot permanently increase the rate of economic growth above its potential or decrease the rate of unemployment below its market clearing, or “natural,” level.

While the phrase policy cannot permanently increase the rate of economic growth above its potential, nor decrease the rate of unemployment below its “natural” level is yet between my ears, my mind is picturing the Dark Age.

There was a time, no doubt, when it was too late to prevent the fall of Rome. But there was a time before that, when the right economic policy might have prevented the fall.

Economists claim that policy is ineffective and that the economy has its own "natural" levels. What they are really saying is they don't know how to make effective policy.

Tuesday, June 8, 2010

Bank Error in Your Favor???

Nah, that only happens when you're playing Monopoly. In real life, bank errors are always in the bank's favor. Funny how that works.

Changes in the Reserve Requirement work the same way: Always in the bank's favor. Wikipedia today says

Western central banks rarely alter the reserve requirements because it would cause immediate liquidity problems for banks with low excess reserves...

But that's not clear. Between the early 1970s and the year 2000, the Fed boldly permitted great changes in bank reserves -- but downward changes, as Eric deCarbonnel's graph shows.

Note: deCarbonnel says bank reserves are already at zero, so Congress ought to let the legal limit to go to zero. I say the fall of bank reserves was the leading edge of a wave of financial innovation that has buried us in debt, and it must be reversed.

It looks like all the banks must have low excess reserves by now. That would account for the liquidity problems they've been having. As deCarbonnel puts it,

In a banking system with no reserve requirements, everything becomes a systematic risk because financial institutions do not have any buffer to absorb losses. Even the failure of a small bank becomes enough to bring down the entire financial system.

Nice, huh? Anyway, it wouldn't be right to set the reserve requirement to zero. After all, the name of our central bank is the Federal Reserve System.

Monday, June 7, 2010

I Have a Question

Remember the really bad inflation we had in the 1970s? Not so bad in the '50s, a little worse in the '60s, then double-digit inflation in the '70s, then not so bad anymore in the '80s and '90s and the years since.

My question: Where do those trend changes show up on this FRED graph?

...Or on this log-scale version of the graph?

I just don't see it. I see a kink in the second graph around 1962. Base money started growing faster then. But it didn't vary much after that point. Money growth follows a straight line from 1962 right up to 2006 or so, where it slowed down to nothing... and immediately we had a fiscal crisis and recession. That's what I see. A brief interruption of base-money growth, followed immediately by trauma.

But there is definitely no pick-up of money-growth that accounts for greater inflation in the 1970s. And there is definitely no slow-down of money growth that accounts for the much-reduced inflation since the 1980s.

Sunday, June 6, 2010

The Rise of Nuclear Power

From today's Parade:
The newest nuclear power plant in the U.S. opened nearly 15 years ago, but many more may be coming soon...

A 2005 law offering incentives for nuclear-energy companies created a surge of proposals, and President Obama has committed billions in federal loan guarantees to aid construction of new plants.

Some experts... note that new reactors create new risk, and that the previously rural areas hosting nuclear plants are now more densely populated.

"The public needs to ensure that emergency planning is adequate."

Energy prices being what they are these days, why would companies need incentives and loan guarantees to get them building new power plants? Isn't profit supposed to be the incentive?

Emergency planning? The solution is not emergency planning. The solution is emergency prevention.

And risk? The risk doesn't come from a more dense population. It comes from cutting corners to save a buck. Profits are low as it is, apparently -- low enough that we need incentives and loan guarantees despite the high cost of energy. Spend a little more on safety and accident prevention, and profits go even lower.

To reduce risk, to increase profit, and to spend for emergency prevention we need a better, healthier, faster-growing, more profitable economy. Until that day comes, a nuclear accident will be just as possible and far more dangerous than a massive and costly oil disaster.

Saturday, June 5, 2010

Four Views

Three excerpts from a post by Ambrose Evans-Pritchard at

1. The Administration: More deficit spending...
Larry Summers, President Barack Obama’s top economic adviser, has asked Congress to "grit its teeth" and approve a fresh fiscal boost of $200bn to keep growth on track.

2. The IMF: Less deficit spending...
The US authorities ... are opting ... for yet further doses of Keynesian spending, despite warnings from the IMF that the gross public debt of the US will reach 97pc of GDP next year and 110pc by 2015.

3. Professor Tim Congdon: More money...
Mr Congdon said the Obama policy risks repeating the strategic errors of Japan, which pushed debt to dangerously high levels with one fiscal boost after another during its Lost Decade, instead of resorting to full-blown "Friedmanite" monetary stimulus.

"Fiscal policy does not work. The US has just tried the biggest fiscal experiment in history and it has failed. What matters is the quantity of money and in extremis that can be increased easily by quantititave easing.

4. One view from li'l ol' me: Less debt...

Over the last 50 years or more, the growth of debt has outpaced the growth of equity (money) at a geometric rate. An exponential rate. The immediate solution, the best way to restore the balance between debt and money, is to convert some of this debt to equity. Convert debt to money. Monetize the debt. ...

The quickest way out is just to print money and use it to pay off debt. But it's like touching a snake, isn't it? You can't stand the thought of it.

Less debt. I'm not the only guy with this plan. Everybody's trying to pay down debt. I'm just the only one saying let's use policy to make it happen. Here, here's something from Krugman, from the Tinkerbell post:

"I’d like to see the Fed add several trillion to its assets. But central banks are leery of doing this, for various reasons, including the fact that they’re taking on risk."

There's risk associated with debt. So not even the Lender of Last Resort wants to take on too much debt. Fair enough. But there's a simple way out of this mess: Let's not have the Fed buy up debt. Let's have them pay it off. When you pay off debt, risk goes away.

Debt goes away, too, and that's what our economy needs.

Friday, June 4, 2010

Confidence Game

This, by Derek Thompson at The Atlantic --

The White House Finally Explains
Keynesian Economics

May 25 2010, 10:00 AM ET

Larry Summers gave an interesting speech yesterday defending and explaining the White House's economic policy at the Johns Hopkins School of Advanced International Studies (SAIS). His thesis was classic Keynesian economics: "Appropriate short-run expansionary budget policy can make an important contribution to establishing the confidence necessary for sound growth," Summers said. In other words, deficits are good, for now, because heavy public spending in downturns is still required to juice long-term growth. ...

Appropriate policy will establish "the confidence necessary for sound growth." As if there were really nothing wrong with the economy. Confidence is our only problem.

Oh, yeah, sure, confidence is a big deal, I don't deny it. Anything can create a panic, even a scary speech. But if the economy is really sound and healthy -- really, not just in political-speech fantasies -- then panics are unlikely, and if we have one it might just fizzle out on its own.

It's only when the economy is weak and listless for years and years and years that a panic or a hiccup can "ignite the final financial crisis."

Confidence is not the problem. Confidence is not the solution. Confidence follows conditions.

You can't restore the economy by restoring confidence. You can only restore confidence by restoring the economy.

Thursday, June 3, 2010

Out of Nowhere

After I did my "Christina at '50" post I came across this Google graph. Looks like nothing happens for a while, then something happens. I guess there's always hope.

Wednesday, June 2, 2010

Goal and Irony

Goal: To achieve economic security. Basically, to have enough money set aside so that come what may, one need not worry about money.

Irony: Too much money set aside (and lent out) creates the come-what-may event.

Tuesday, June 1, 2010

Christina at '50

This post is displayed in short form with spoiler links you can use to show or hide more text. This is a nifty feature of HTML, and I hope you find it enhances the post. (Requires Javascript to toggle the text.)

A review of "A Rehabilitation of Monetary Policy in the 1950s" by Christina D. Romer and David H. Romer. The paper is from The AEA Papers and Proceedings, May 2002. (Link to PDF)


The PDF is well-organized, brief (7 pages) and quite convincing. The authors note that Federal Reserve policy before the 1980s is not well regarded by modern economists. The article holds that 1950s policy is comparable to modern policy, while policy of the '60s and '70s is not. The article offers "a rehabilitation" of the modern view of 1950s Fed policy.


Here are the opening sentences from the first three paragraphs of the article:

American monetary policy in the 1950's has typically not been judged favorably. These unfavorable judgments seem strangely at odds with economic performance in this decade. This paper suggests an alternative view of monetary policy in the 1950's, and hence a possible solution to the mystery of that decade's outstanding economic performance.
They fit together exceptionally well.

Each paragraph expands upon its opening sentence. The first identifies critics and criticisms of 1950s policy. The second identifies economic performance criteria and performance achieved. The third outlines the organization of the balance of the paper.

The balance of the paper follows that outline, even down to the detail of using header lines with outline-style numbering. These are the headings:
  1. Narrative Evidence
    1. An Overarching Concern about Inflation
    2. Model of the Economy
    3. Implementation of Policy
  2. Statistical Evidence
    1. Specification
    2. Results
  3. Conclusion
The paper also includes one table, two figures, five footnotes, and over a dozen references.


The paper presents the myopic and egotistical view that '50s policy was right because it is comparable to modern policy. This view is presented more than once.

The authors write: "We show that policy in the 1950's was actually quite sophisticated." They do not say "actually quite sophisticated by present standards;" but that is clearly what they mean. Those Neanderthal economists of the '50s were darned near as good as we are, dear.

They do not say "the policy of the 1950s was surprisingly sophisticated," which would have expressed surprise. They say policy was "actually quite sophisticated." The words actually quite seem to suggest arrogance rather than surprise -- as if coming from a position of modern superiority.

The authors write of "unquestionably good economic performance" and "outstanding economic performance" to describe the 1950s. There is a backwash effect from this: They were outstanding. And they are actually almost quite as good as we sweet moderns. So we are outstanding, too. QED.

The authors write: "Their model of how the macroeconomy operated contained ... a remarkably modern view of the causes of inflation...." And the article praises the 1950s for its "sensible view" of full employment -- again meaning a view that seems sensible by present standards. The economic thinking of the 1950s is held to be almost as good as ours today: remarkably modern and sensible.

The authors also contrast 1950s policy to that of the 1960s and '70s. To the latter is attributed a "simplistic Keynesian model." This is mere taunting. The authors write:

"If monetary policymakers in the 1950's had figured out the essence of sensible policy, the mistakes of the 1960's and 1970's cannot just have been the result of continuing ineptitude or misunderstanding. Rather, something must have changed."
This is really well-crafted stuff; the authors manage to align modern policy with the sensible 1950s, and at the same time jab a finger in the eye of the 1960s and '70s.

I hesitate to offer this particular criticism of the paper. For it is not economics to say: They are good, for they are sensible, like us. Nor is it economics to say: They are not good, for they are different and simplistic. This is not economics at all. Yet it seems somehow to have become part of modern economics. So I point out the flaw.

At no point in the article is it suggested that present-day economic conditions are excellent; only that present policy is. But how can policy be good, when it produces an economy such as ours? Financial crisis, recession, debt, unemployment, inflation, and lethargic growth. The egotistical vision of present policy as the best of all possible worlds is a major flaw in the paper.

If Romer and Romer want to say the policies of the 1950s are similar to those of recent times, all well and good. But they assume present policies are right, and they compare '50s policy to this modern perfection. It would be funny, if economic conditions today didn't create such problems for so many people.


The authors gather interest-rate data from two sources: from Citibase, as far back as 1954; and for older data they took an old graph and guesstimated what the numbers must have been. (The authors call it "deducing the numbers from the graph.")

But then, it's not as bad as it sounds, because they ignore half of their guesstimated numbers. The authors note that for their 1950s data they take the period including only 1952 through 1958. Seven years out of ten. They explain:

We start two years into the decade because the Federal Reserve was unable to pursue independent monetary policy until the Treasury-Federal Reserve Accord of 1951. We stop at the end of 1958 for reasons discussed below.

The data doesn't show what they need it to show in 1959, so they dropped that year from their calculations!

1959 is omitted from the Table 1 calculations, because it makes their bad statistical evidence look even worse. Include that bit of data, and the evidence fails to support the claims made in the article. The weight on inflation is estimated imprecisely enough as it is, the authors note, and

Furthermore ... if one continues the estimation through 1959 the estimated coefficient on inflation falls considerably and is measured even more imprecisely.

Note that if the weight falls "considerably," it no longer supports the view that anti-inflation policy was vigorous in the 1950s. If it falls from 1.178 to anything less than 1.0, it no longer indicates that the Fed raised real interest rates in response to inflation.

Stopping at 1958 concerns me much more than starting at 1952. The "reasons discussed below" turn out to be that including 1959 would have made the authors' claims look false. But this hardly seems to matter, as the authors boldly assert

Empirical analysis of the behavior of the funds rate shows that policymakers in the 1950's responded much more aggressively to expected inflation than did policymakers in the 1960's and 1970's.

That's an unsupported claim, given the imprecision and the careful selection of both statistical and narrative evidence to obtain the desired result.


The narrative evidence consists of a bunch of excerpts -- 27, by my count -- mostly from the Minutes of the Federal Open Market Committee.

"Given that the time period is short," the authors write,

it is hard to test statistically whether the Federal Reserve of the 1950's was blessed with good sense or good luck. For this reason, it is most useful to analyze narrative evidence.

So they analyze 27 excerpts selected from ten years of Minutes of Federal Reserve meetings. "The overarching concern about inflation is revealed most clearly," they write, "... during the times when inflation began to accelerate ... in the mid and late 1950's."

They consider 11 excerpts from the mid 1950s and 16 from the late 1950s. Not one from 1957. None from 1954, 1953, 1952, 1951, or 1950. Surely if the concern was "overarching" the Fed must have been just as concerned about inflation when prices were stable as when prices were rising. Surely also, one could find 27 or more strong statements of concern about inflation from Federal Reserve members during the 1970s, when inflation was heading into double-digits. The narrative evidence is suspect on these grounds alone.

One reason the article is convincing is that it arouses nostalgia. The excerpts recall mysterious and memorable names like Watrous Irons and William McChesney Martin. Of course, you cannot base an economic argument upon nostalgia.

You cannot base one on narrative excerpts either, as the authors point out: "To see if policymakers backed up their words with actions, one needs to supplement the narrative analysis with statistical evidence."

The statistical evidence uses "regression" and the "Taylor rule" to compare monetary policy decisions of four time periods -- the '50s, the late '60s and '70s, the '80s, and the '90s.

The "Taylor rule" calculation combines output and inflation performance data to calculate an interest rate. This rate is considered (by economists) to be a target for monetary policy: The Federal Reserve simply aims for that interest rate target, and all is then right with the world. (The Taylor rule itself is a remarkable product of modern egonomics. See this post for more.)

In the calculation, different "weights" are assigned to the output and inflation data, based on their importance in calculating the interest-rate target. A big part of the science of using the Taylor rule seems to be to come up with the right weight-values. That's where "regression" comes in.

The authors do some really nifty arithmetic: The article claims that monetary policy was tougher on inflation in the 1950s than in the '60s and '70s. The argument is simple: If the "weight" is greater in the 1950s, then the policy was tougher. The logic is elegant.

However, they admit that

"The weight on expected inflation is estimated less precisely in the 1950s than in other decades"
In other words, their evidence is not precise. The authors refer the reader to "the narrative evidence presented in Section I" to make their case. Our statistical evidence is junk, they tell us. So here, look at the cherry-picked quotes we showed you above.

Oh -- and for the record: Their calculated "weight on expected inflation" in the 1950s is 1.178 with an "error" factor of 0.876. The error value is 74% of the weight value. That's a mighty big margin of error. The phrase "less precise" doesn't do it justice.

Their calculated weight on output is also "very imprecisely estimated."

The narrative evidence makes a nice story. But it is only one of many possible stories we could find in a selective summary of a ten-year collection of statements. A different selection of narrative evidence could easily support a completely different conclusion. The narrative evidence is weak.

As the authors note, "One needs to supplement the narrative analysis with statistical evidence."

But the statistical evidence is also weak: "Because the 1950's sample period is inherently limited and the variability of inflation in this decade is small" -- that, yes, and the bad weight estimates, and the careful selection of evidence -- "this empirical analysis must be viewed as a suggestive check on the narrative analysis rather than as a conclusive test."

The statistical evidence is inconclusive, and the authors refer more than once to the narrative to strengthen their case. The argument presented -- by the current head of the Council of Economic Advisers -- is based on the principle that a chain with two weak links is somehow better than a chain with one.


1. The article's conclusion states: "Monetary policymakers of the 1950s had a deep-seated dislike of inflation and acted to control it." I'm willing to accept that view. But nowhere in the paper is the correctness of the policy actions evaluated. The policies are simply assumed to be good because we like them.

In 2002 when the article was published, modern policy was assumed to be good. Six years later we found out different. And then Christina Romer became the Chair of the Council of Economic Advisers. But things are amiss here, and good science is lacking.

2. William McChesney Martin was head of the Fed from 1951 to 1970: the '50s and the '60s. But according to the Romers, policy was good in the '50s and bad in the '60s. So what happened? Martin's brilliance in the 1950s suddenly turned into ineptitude and misunderstanding? Oh, oh, oh, the model of the economy changed, they say. William McChesney Martin must have adopted "a naive Keynesian model" and abandoned his "overarching concern about inflation."

I don't buy the argument.

3. The Taylor rule can be used to calculate an interest rate target. But this does not mean that the whole concept of monetary policy as implemented today is correct. The calculation works like the Holodeck on Star Trek -- or like any computer program: The outputs are only as good as the assumptions allow. Garbage in, garbage out.

The Taylor rule produces a number that economists think should be the right number, based on their incomplete and flawed understanding of the economy. Confidence in the Taylor rule presupposes that the modern understanding of economic forces is accurate and complete.

4. I am suspicious of the data omission. The authors omit not only 1959 from their survey, but also the first four years of the 1960s. Data points stop in 1958 and do not resume until 1964. That's a five-year stretch, ignored because at least one of the missing years throws off the results. I suspect the whole five-year stretch contradicts the article's view.

And as it happens, the omitted period is the key turning point noted in my 12-page PDF. I do not think this is coincidence. The facts of those years are not explained by the Romer paper. This failure of their explanation shows that some other explanation of inflation is needed.