DeLong and Short of it

DeLong (h/t Jazz):

In 1950, finance and insurance in the United States accounted for 2.8% of GDP, according to US Department of Commerce estimates. By 1960, that share had grown to 3.8% of GDP, and reached 6% of GDP in 1990. Today, it is 8.4% of GDP, and it is not shrinking.

Jazzbumpa:

The yearly values for GDP growth since the 50's are contained in a collapsing envelope, indicated by the green trend lines. These lines converge at about 1.8% in 2028. Make of it what you will.

Graph #1

Graph updated 2 Jan 2012.

NYRs

I was gonna say I'm not gonna try so hard this year to have a post every day. But I changed my mind. I AM gonna try so hard to have a post every day.

I'd like to organize my post tags slash labels better, and put a bibliography and some other stuff together for "pages". Dunno if "like to" counts as a New Year's resolution.


I want to write better descriptions. For example, when I wrote

...treating it as the kind of fact that always has been...

the "kind of" was kind of weak. I changed it to "sort of" but that was sort of weak, too. And they were both ambiguous: Did they mean "actually quite" or did they specify a type of fact? I went back-and-forth between kind of and sort of a few times, then suddenly settled on type of:

...treating it as the type of fact that always has been...

Words matter. John Madden used to talk about "the red zone". And then everybody was talking about "the red zone". Except one announcer, who kept talking about "the red area". It was just so wrong.

And I want to write stronger conclusions. In large part, this means that if I write a sentence and you are supposed to draw a conclusion from it, then I am supposed to actually write that conclusion, so that we both know what I was thinking.

And I want to avoid alienating people. (Yeh, I have to write that one down, or I won't think of it.)

In sum: better descriptions, better conclusions, and a better attitude.

Happy New Year.

p.s. More posts on private debt. I hereby resolve. At least once a month.

Maybe every week.

Keen

Steve Keen took a survey and wrote about it.

The first question:

Is it important for the Commonwealth government to aim for a budget surplus in 2012-13? Why? Should it continue to aim for surplus even if international conditions worsen?

Keen's answer:

NO! It’s a nonsense neoclassical fantasy to blame this crisis on government debt, when its underlying cause has always been a private sector debt bubble that has now burst. Now that the private sector is finally deleveraging in Australia (after the First Home Vendors Boost delayed the process), the last thing we need is for the public sector to also be pulling money out of circulation, which is what a government surplus would do.

Keen does not "blame this crisis on government debt". Keen is right.

The cause, he says, is "a private sector debt bubble that has now burst." A debt "bubble" refers to rapid growth of debt. 'Rapid growth' of private sector debt is very close to what I say is the problem. I say the accumulation of private debt became unsupportable. Of course, the rapid growth of debt made the accumulation unsupportable sooner. But it would have happened anyway, eventually, when slowly growing debt reached an unsupportable level.

Finally, Keen says "the last thing we need is for the public sector to also be pulling money out of circulation". And I say we need to increase M1, which is money in circulation. See how close we are, me and Keen?

He says debt was growing too fast, and money isn't growing fast enough.

I say we must reduce the debt-per-dollar ratio.

Same thing.

Unexpectedly weak productivity growth

Graph #3 from yesterday:

I want to see those increases in output per hour. So I turned off the log scale and looked at "percent change from year ago" values:

Not so obvious before 1960 where the recessions are close together, but after 1960 it seems that productivity spikes up immediately after a recession, then trends more slowly downward to the next recession. You can see it after the 1960 recession and maybe the 1970 recession and definitely after the 1974 recession and the 1982 recession and the 2001 recession.

It is worth repeating that the "normal" pattern is a rapid increase in productivity immediately following a recession, then a gradual decline continuing to the next recession. However, we do not see that normal pattern following our most recent recession. Instead we see a rapid increase in productivity, and a rapid decline.

"unexpectedly strong productivity growth"

From the same Working Paper I referenced yesterday morning:

During the so-called “New Economy Era,” labor productivity (output per hour) played a key role in shaping the Federal Open Market Committee’s (FOMC) response to evolving economic conditions. Indeed, productivity discussions have a long history at FOMC meetings. For instance, unexpectedly strong productivity growth during the early 1980s generated arguments that would become familiar to participants more than a decade later.

Hmm. Productivity growth during the "New Economy Era" of 1994-2001... and productivity growth "during the early 1980s".

Went to FRED. Searched for output per hour. Found 26 series. Some are for manufacturing in other nations. Some have start-dates in the 1980s and 1990s. I sorted the results by start-date, selected the four domestic (U.S.) series with start-dates before 1960, and clicked Add to New Graph:

Graph #1: Four Measures of Output per Hour

Next, I looked at it on a log scale, because it was easy to do:

Graph #2: Same as the first graph, but on a Log Scale

I want to see the changes in output per hour. So I turned off the log scale and looked at "percent change from year ago" values:

Graph #3: Same as the first graph, but as Change from Year Ago

Not so obvious before 1960 where the recessions are close together, but after 1960 it seems that productivity spikes up immediately at the end of a recession, then trends more slowly downward to the next recession. You can see it after the 1960 recession and maybe the 1970 recession and definitely after the 1974 recession and the 1982 recession and the 2001 recession.

But not after the 1991 recession. From maybe 1993, productivity trends upward to 2000 or later. This difference corresponds to the "New Economy Era" (1994-2001) described in the working paper. This is the same period that Robert J. Gordon has called the U. S. macroeconomic miracle.

I want to focus now on Output per Hour in Manufacturing in the United States, the green line from Graph #3 above:

Graph #4: Output per Hour in Manufacturing (U.S.)

I see two spikes between 1982 and 1990. The first comes at the end of a recession. The second comes later, more like the result of a "miracle" than the aftermath of a recession. This, I suspect, is an indication of the "strong productivity growth during the early 1980s" noted in the working paper. Despite the date discrepancy.

Now I want to take Graph #4 and add to it in red the percent change numbers for base money:

Graph #5: Growth rates of Output per Hour (green) and Base Money

Between the 1974 and 1980 recessions the red and green lines quite clearly move in opposite directions. But that pattern changed. Coming out of the 1982 recession productivity and money growth peak twice, simultaneously, before the next recession. Then, beginning with the 1991 recession, both lines show a third peak, this time a double-peak. And in the latter 1990s -- the "new economy" years -- the red and green lines quite clearly move together.

The three peaks I point out, between the 1982 recession and the mid-1990s, are the same three bumps I have pointed out several times before on this blog.

The red line on Graph #5 shows the growth rate of base money. For the record, base money is money actually issued by the central bank of a country.

Those bumps in the money are part of a policy that allowed "unexpectedly strong productivity growth" to develop, ever so briefly.

It's a start

Krugman:

Private debt... doesn’t directly make us poorer, but it increases our macroeconomic vulnerability.

Yeah. It makes financial crisis possible. It makes debt-deflation possible. It makes bizarre policy responses necessary, so that people question government more. And like that. Macroeconomic vulnerability.

Plus, it increases financial income relative to productive income. This is good for the growth of finance and speculation, and bad for the growth of output.

Excessive private debt is the original source of inadequate growth. Plus, it increases costs, and drives cost-push inflation. And like that.

Shocking answers

Not long ago, at Asymptosis:

The Fed Always Thinks That Unemployment’s Not a Problem

Their model is obviously telling them that whatever (non-)actions they’re taking at the moment will solve the problem.

And their model is obviously, consistently, and wildly wrong — and always wrong in the same direction.

Altering that model to accurately predict unemployment, of course, would require that they allow more inflation in order to address both of their mandates.

And higher inflation utterly slams the real wealth of creditors.

And the Fed is run by creditors.

From the St. Louis Fed, Working Paper 2011-041A by Richard G. Anderson and Kevin L. Kliesen:

How Does the FOMC Learn About Economic Revolutions?
Evidence from the New Economy Era, 1994-2001

For monetary policymakers, and for business economists, a major challenge is tracking, understanding, and recognizing changes in the economy as they occur. Economists are fond of modeling economies as mathematical systems but some policymakers—former Fed Chairman Alan Greenspan, perhaps most notably—emphasized that model uncertainty causes monetary policy to be an exercise in risk management. In this framework, policymakers seek to learn about the changing economy even while they adopt policies that hedge against large unfortunate outcomes not well captured by the forecasting models.

Asymptosis and Greenspan agree that the models are a problem.

In Greenspan’s view, therefore, policymakers are rarely sure of which probability distribution they are confronting. Thus, the prudent course of action is an application of Bayesian decision making: (i) gather as much information as possible; (ii) quantify the probability of possible outcomes; and, (iii) act aggressively to hedge against potentially catastrophic outcomes (deflation or depression).

So the problem is perhaps not as simple as the Asymptosis post would have us believe.

I still haven't figured out "Bayesian". But the definition of "potentially catastrophic outcomes" is clear. It should be clear also that "hedging" against catastrophe suggests that policymakers have no clue what's wrong with the economy, nor how to fix it.

During the so-called “New Economy Era,” labor productivity (output per hour) played a key role in shaping the Federal Open Market Committee’s (FOMC) response to evolving economic conditions. Indeed, productivity discussions have a long history at FOMC meetings. For instance, unexpectedly strong productivity growth during the early 1980s generated arguments that would become familiar to participants more than a decade later. Questions such as: How much should the Committee risk its price stability goal to gamble that nascent accelerations in productivity will persist? If the Committee were to regard the risk as unacceptable and tighten policy preemptively—as suggested by inflation forecast targeting with models that do not incorporate the positive shock to productivity growth—how much output is lost? And, how does this interact with the FOMC’s dual mandate from the Congress to seek both price stability and maximum sustainable economic growth?

I have an advantage over the Fed. I don't operate in real time, setting policy based on the latest news reports. I just look at the past and evaluate trends.

But sometimes I have to wonder whether the Fed ever looks at the past and evaluates trends. Oh, sure, "unexpectedly strong productivity growth during the early 1980s generated arguments that would become familiar to participants more than a decade later." But more than a decade later the FOMC had progressed only toward greater uncertainty. "Knightian" uncertainty.

I can tell you why they are uncertain: They don't look for answers. They say things like "models that do not incorporate the positive shock to productivity growth" as though by calling it a "shock" all questions are answered. Don't stick your finger in the socket.

"Why, Mommy?"

"Because you'll get a shock."

It is an answer appropriate for children. It is not appropriate for the Federal Reserve.

In this article, we thus examine how monetary policymakers recognized and responded to the productivity acceleration of the 1990s.

The focus on self is not productive. Rather than examine how policymakers recognized and responded, it is necessary to examine the underlying causes of the productivity acceleration of the 1990s.

And as a hint in what direction the analysis should proceed, consider that the Federal Reserve sets monetary policy. The appropriate analysis is the analysis of monetary causes of the productivity acceleration of the 1994-2001 period.

A Stronger Argument is Needed

In Debt and Growth in the G7, Paul Krugman writes: "I’ve written fairly often about the often-cited Reinhart/Rogoff claim that terrible things happen to economic growth if the ratio of debt to GDP exceeds 90 percent. It’s a claim that has been pretty thoroughly debunked," he says, linking back to his own stuff.

PK shows a graph of

the debt/GDP ratios of the G7 countries since 1946, together with a line representing the famous 90 percent threshold. What do we see? The answer is that the >90 club consists of the English-speaking nations in the immediate aftermath of World War II, Britain for a longer postwar stretch, Italy since the late 80s, Japan since the mid-90s, and a couple of years in Canada.

I would call his tone dismissive. Krugman notes the occasions when the ratio was over 90, but does not dwell on the problematic aspects of those occasions. Fair enough. His point is that debt above the 90% level isn't a problem. But he does not make a strong argument. He notes the facts and dismisses them.

Krugman provides one paragraph in defense of his view, and a summary line:

The English-speaking economies contracted in the years immediately after the war, not because of debt, but because Rosie the Riveter went back to being a housewife. Italy and Japan both experienced sharp growth slowdowns before their debt went so high, and you can make a strong case that slow growth caused high debt, not the other way around.

So this really looks like a case of spurious correlation...

The "Rosie the Riveter" line could be developed into an argument about an economy dealing with major changes due to the ending of a major war, but Krugman doesn't bother. Nor does he explain why the (presumably brief) contraction after the war was brief, nor why it was immediately followed by a golden age of economic growth. Here again, this could be a strong argument.

And as for Italy and Japan, PK says "you can make a strong case that slow growth caused high debt" (my emphasis). But Krugman does not make that case, either.


1. Krugman does not make clear that his discussion excludes private debt.
2. He dismisses claims that 90% is a problematic level for debt.
3. He admits there was a contraction after the war and provides an explanation but no evidence to support it.
4. He fails to point out the 25 years of superb growth that followed the brief contraction, and fails to show how this growth occurred despite (or perhaps because of) the high level of debt.
5. He fails to make the one "strong case" that he says can be made. And what is Krugman's strong case? "Slow growth caused high debt". Even if PK made this case, it would be a weak argument.

When you leave private debt out of the picture, it is difficult to show that private debt is the cause of the slow growth that "caused high debt".

Unit Labor Cost

Nuance++

From mine of the 22nd... from Wikipedia:

Within mainstream economics, levels and flows of public debt (government debt) are a cause of concern, while levels and flows of private debt (especially households and corporations) is not seen as being of central importance.

Okay. But there is "economic evolution". The economy changes all the time. Private debt has become a problem of central importance.

Consider that the Federal Reserve was not created until 1913. Fed policies have been developing since that time. And the U.S. was still on a gold standard until the 1930s. So the door was wide open for economic evolution in the decades after WWII.

As things stand today, there can be no doubt that private debt has become a problem of central importance. But perhaps there was a time when private-sector debt was never a problem. As I wrote in my series on the Free Banking era of 1836-1863:

money being tied to gold would have changed the nature of the problem. It would have changed the way the problem worked itself out.

"The early panics," Rothbard wrote, "seemed to be ten years apart: 1837, 1847, 1857..."

In those days, gold was money. Money was gold. Banks issued paper money that was exchangeable for gold. You'd come home from the market, or come home on payday, take the money out of your pockets, and put it on the kitchen table.

If it was mostly gold, that was obvious.

If it was mostly paper, that was obvious too.

When the money started to be mostly paper, people got concerned. They started taking their paper to the bank to get hard money for it. To get gold.

Zoom out and look at that, and you can see a "panic" develop.

In the 19th century there never got to be an extreme imbalance between money and debt like there is today, because it was easy to tell the difference between money and debt. If it was gold it was money. If it was paper it was somebody's debt. And panics flushed debt from the system frequently.

When money was gold it was easy to see the difference between money and debt. It is not so easy to see the difference anymore, because money is paper and debt is paper. Or today, both are "notations". Even harder to see.

Evolution.

In the Free Banking Era, there were frequent panics, too frequent to permit debt accumulation like the bizarre, inexplicable debt accumulation we have today. Those panics kept recurring every few years, flushing debt from the system. In the 19th century, frequent panics prevented debt from accumulating the way debt has been accumulating for us since World War Two.

So perhaps it is true that in the 19th century, private debt never became a problem. Or at least it was a self-correcting problem.


I'm quite certain it is true also that the great body of Western economic thought originated in that same 19th century. Oh, sure, there was Adam Smith a little early, and Maynard Keynes a little late. But in the years between those two men, the foundation of what we think of as "modern" economics developed.

Look at recent thought: It's mostly based on Say's law and Ricardian equivalence and on what Keynes called "classical" economics. It's mostly based on economic thought from a time when gold and recurring panics prevented debt from becoming a problem.

Evolution.

It's time to flush 19th century thinking from the system. It's time to accept the fact that private debt accumulates until it becomes a problem. People know it already. Debtors know it, and creditors know it too. The only people who don't seem to know it are our modern day 19th-century economists.

Odious policy

From Wikipedia, the free encyclopedia:

Odious debt

In international law, odious debt is a legal theory that holds that the national debt incurred by a regime for purposes that do not serve the best interests of the nation, should not be enforceable.

I got that far, and I said Oh, yeah! This is how we solve the debt problem.

Such debts are, thus, considered by this doctrine to be personal debts of the regime that incurred them and not debts of the state.

Well... it will take some work. Change "regime" to "policymakers", and "not debts of the state" to "not debts of the people" and that should take care of it.

The doctrine was formalized in a 1927 treatise by Alexander Nahum Sack...

According to Sack:

When a despotic regime contracts a debt, not for the needs or in the interests of the state, but rather to strengthen itself, to suppress a popular insurrection, etc, this debt is odious for the people of the entire state. This debt does not bind the nation; it is a debt of the regime, a personal debt contracted by the ruler, and consequently it falls with the demise of the regime.

Change "despotic regime" to "well-meaning and benevolent government". For a reason, say "because it mistakenly thinks it is in the best interest of the people to encourage their use of credit and accumulation of their debt".

Say "This bizarre and unnatural growth of debt was the result of a misunderstanding of economic principles, and consequently it falls with the demise of the policy".

That works for me.

And then I read the first footnote:

Graeme Smith A new euro crisis strategy: deny the debt The Globe and Mail 20 November 2011

And discovered that I was neither the only person nor the first to think we can reduce debt by treating it as odious. You have to be a subscriber to see the linked article. But you can also read it at http://www.europe-solidaire.org/spip.php?article23575.


Graeme Smith writes:

When demonstrators scream “Make the bankers pay,” or the equivalent in Greek, Spanish, or Italian, many of them are embracing a concept that has gained popularity during the crisis. It’s a deceptively simple way of dealing with a crushing sovereign debt: Declare the loans illegal, or “odious.”

I'm in.

The argument is that when a lender knowingly gives money to a corrupt or dictatorial regime for purposes that don’t benefit the country, the debt should be erased when the tyrant falls.

When lenders profit from incorrect and unsustainable economic policies, regardless of the purposes of those policies, the debt should be erased when the policies fall.

None of Europe’s finance ministers have proposed anything of the kind, but they have been forced to explain why not...

Ireland’s Finance Minister quickly dismissed the proposal as “deranged and crazy”...

Well, sure. Because the alternative to saying "deranged and crazy" is to say Yes, our policies were foolish. Yes, our policies were wrong.

Merry Christmas

Maynard Keynes:

When the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals. We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues. We shall be able to afford to dare to assess the money-motive at its true value. The love of money as a possession – as distinguished from the love of money as a means to the enjoyments and realities of life – will be recognised for what it is, a somewhat disgusting morbidity, one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease. All kinds of social customs and economic practices, affecting the distribution of wealth and of economic rewards and penalties, which we now maintain at all costs, however distasteful and unjust they may be in themselves, because they are tremendously useful in promoting the accumulation of capital, we shall then be free, at last, to discard.

RGDP: Annual Change and a 21-Year Moving Average

I was impressed by Jazzbumpa's 21-year moving average in his Disturbing Look at GDP Growth. So I decided to extend the 21-year M.A. as far out in time as I could.

For the U.S., the annual "Real GDP" numbers from Measuringworth run from 1790 to 2010. I figured "percent change from year ago" from that, so my first number is for 1791. And I figured a 21-year average and plotted it at the last year of the period, so my first M.A. comes in at 1811. So, I got a hundred numbers to look at.

Graph #1

Sorry about the scrollbar. Without it, Google Docs was just ignoring everything after the mid-1950s. Information overload, I guess.

A Christmas Story

From FT via Gang8.

"The Meme that Refuses to Die"

At EconoSpeak, a good one from Peter Dorman. (I can't take an excerpt from it; you sort of need to read the whole thing.)

In the comments, Don Levit asked a good question and I gave an impromptu answer.

I often have second thoughts when I don't put enough time into something I write. So I'm looking again at my reply, giving myself a chance to fine-tune it.

Anyway, here is my comment, tweaked:

Don's question is excellent:

How was the economy able to do so well for the years 1950-1980 with very little government debt, yet for the last 30 years, with huge government debts, median households have lower incomes?

The answer is found by comparing the level of government debt to the level of private debt. For it is private debt, not government debt, that holds back private sector growth.

For the last 30 years, private debt has been so vast that all of the growth of government debt we've had was not enough to generate vigorous growth.

For the 30 years before that, private sector debt was relatively low, so it was able to increase rapidly, creating vigorous economic growth.

The changes of the past 30 years -- Reaganomics -- skewed income toward the top. That's why the median income fell. And the fall of median income is a problem. But those changes were designed to solve a prior problem, the problem that GDP (total income) growth was too slow.

GDP growth was already inadequate in the 1970s, because of excessive private debt.

Nuance??

Wikipedia:

Debt levels and flows

Debt is used to finance and pay for entreprises and business around the world. The levels of debt – how much debt is outstanding – and the flows of debt – how much the level of debt changes over time – are basic macroeconomic data, and vary between countries.

Within mainstream economics, levels and flows of public debt (government debt) are a cause of concern, while levels and flows of private debt (especially households and corporations) is not seen as being of central importance.

Apart from the spelling, there are at least two problems with this introductory bit of the article.

1. Debt is used "to finance and pay for" stuff.

No, it's not.

A debt is an obligation owed by one party (the debtor) to a second party, the creditor.

If I borrow a dollar from you to get a candybar from the machine, two transactions occur:
   1. You give me a dollar and I give you an IOU.
   2. I give the machine a dollar and the machine gives me a Milky Way.

Two transactions. The first one puts money into circulation and creates debt. The second one uses the money to make a purchase.

The second transaction is completed as soon as I have my candybar in my hot little hand. The first transaction is not completed until I repay the debt.

We might say debt is used "to finance" the candybar. But debt is not used to "pay for" it. The money I get in exchange for the IOU is what I use to pay for the candy.

I'm not inventing any stories here. I'm just trying to be clear about what happens.

2. Private debt is not seen as a problem.

No, it's not. It *IS* a problem, but it's not seen as a problem. And to be blunt, that is the reason we cannot solve the problem.


I've said it before, but you and I are like little versions of the Federal Reserve. The Fed puts new money into circulation by buying stuff from the private sector. So do we.

What's different is where the new money comes from. You and I have to go to the bank to get it. But the Fed *is* a bank, so they don't have to "go" to the bank.

The Fed is a special case. That's where our money comes from. The Fed has a limitless supply of money that they are keeping out of circulation. That's their job, to keep most of that money out of circulation.

If they want new money, they can get it out of an empty box.

You and I are not so lucky. We have to go to the bank for new money. We, unlike the Fed, create debt when we create new money. And we, unlike the Fed, are obligated to pay back that debt.


Every dollar of debt is the record of a dollar somebody put into the spending stream, and has not yet removed from the spending stream.

Every dollar of debt is a dollar somebody has to pay interest on. The money used to pay interest goes into the financial sector. Maybe it came from the financial sector, or maybe it came from the productive sector, but it definitely goes to the financial sector. And most of it comes from the productive sector.

Interest is income to the financial sector. Interest is a cost to the productive sector. You don't need any more explanation than that to see why excessive levels and flows of private debt can become the problem of central importance.

The Interaction of Cycles

But there is no ground to believe that there should be just one wave-like movement pervading economic life.

-- Joseph A. Schumpeter

Wandering through Google results for unemployment historical data the other day turned up The Natural Rate of Unemployment, a PDF by David Brauer of the Congressional Budget Office. (16 pages, lots of pictures.)

The paper is from April, 2007 -- shortly before the crisis. Brauer's Figure 2 shows a prediction based on pre-crisis thinking:

Brauer's Figure 2: Demographics and the Natural Rate of Unemployment

David Brauer writes:

In its summer 2006 forecast, CBO reduced its estimate of the current natural rate from 5.2 percent to 5.0 percent, reflecting a decline since the mid-to-late 1990s in the share of the labor force that is below the age of 25. That decline is attributable not to a change in the age mix of the general population, but to an unexpected sharp and sustained drop in the labor force participation rate of teens and young adults, most likely because of higher rates of school enrollment.

Weird science:

1. People can't find work.
2. People go to school to improve their chances of finding work.
3. The "labor force participation rate" falls because people are in school.
4. The "natural rate of unemployment" falls.

It's sort of like: People can't afford so much steak, so they switch to pasta. And then steak is taken out of the "basket of goods" used to figure inflation, and pasta is put in. Because of this change, the inflation rate number is less. This is sick-puppy arithmetic, all of it. And bad economics.

But that's not why I called this meeting.


I think it's a little funny that the projected rate is five point oh! percent. The number wants to convey more accuracy than it can hold, I think. And once that trend line hits 5.0, it is rock-solid. A straight-line projection out to 2015 and beyond. Laughable.

I also think it's a little funny that in 2006 when CBO reduced its projection to 5.0 percent, apparently they reduced it all the way back to the year 2000.

We have always been at war with Eastasia. But that's not why I called this meeting.


Here is the opening sentence from the Abstract of Brauer's paper:

This paper assesses the natural rate of unemployment—the unemployment rate that arises from all sources other than fluctuations in demand associated with business cycles.

A simple definition. Unemployment arising from all sources other than business cycles. And that brings us to today's agenda: the fluctuations that are associated with business cycles.


In his Kondratieff rejection piece, Murray Rothbard wrote:

... the market is a seamless web. All facets of the market are interconnected through the price system, and the profit-and-loss motive. Booms and busts spread throughout the system; that is precisely why they are important. It is absurd to think that one part of the economy can peg along on a nine-year cycle, another on a three-year cycle, and still another on a 25-year cycle, with each of these cycles barreling along on a hermetically sealed track, not influencing and modifying each other. In fact, there can only be one real cycle going on in the economy at anyone time.

Rothbard is right:  It *IS* absurd to imagine completely separate cycles existing with absolutely no influence on each other. On the other hand, it is not absurd to imagine that more than one cycle might arise from economic forces generated by concurrent economic activity of billions of people spread over the face of a planet. Nor is it absurd to imagine such cycles themselves in continuous interaction.

It is, however, absurd to invent the notion of the non-interaction of cycles, pretend that others invented the notion, and then reject the work of others by saying that the non-interaction of cycles is absurd.


In Business Cycles (PDF, 385 pages apparently), on page 209 Schumpeter attempts to present an extremely simplified or "clean" version of the interaction of business cycles. He limits his presentation to three cycles only, "for the sake of simplicity". He eliminates not only other cycles but also "external disturbances" and also "Seasonals and Growth". And he makes his three cycles as regular and unvarying as possible by using "three sine curves the amplitudes of which are proportional to their duration".

Schumpeter warns that this is a great simplification: "Of course, we do not, as a matter of principle, postulate either internal regularity or sine form...

...we may look upon the charts as an illustration of all the boldest assumptions which it is possible, and to some extent permissible, to make in order to simplify description and to construct an ideal schema with which to compare observations. In particular, all cycles have four phases of equal length, amplitudes of plus and minus excursions are equal and constant, periods are also constant, and each of the two higher cycles consists of an integral and constant number of units of the next lower movement."

And then Schumpeter provides Chart 1, showing the interaction of cycles:

Take three extremely regular wave-patterns and add them together, and you get a surprisingly complex shape.

Schumpeter:

For the stranger to statistical technique the fact alone that extreme regularity of but three components may result in so very irregular-looking a composite should be instructive.

Schumpeter argues that the cycles *DO* interact.

I didn't find the reference, but Schumpeter also argues that if time and chance should bring the lows of various cycles together, the combined low would be deeper than any of the individual lows alone. You can see this behavior on his chart.

Schumpeter said this concurrence could explain the severity of the Great Depression. I don't necessarily buy that explanation of the Great Depression. But I certainly buy that such a thing could happen. So I have to reject Rothbard's assertion that "there can only be one" cycle.

Evolution

Krugman:

David Warsh finally says what someone needed to say: Friedrich Hayek is not an important figure in the history of macroeconomics.

Thus ensued my first visit to economicprincipals.com ("David Warsh, proprietor"). It looks a bit like a newspaper column. Perhaps it induces me to read. Anyway, I do.

Warsh trashes, thrashes, and tongue lashes Hayek for 60 of 64 column inches. Then, something surprising happens: In the last four of those inches, Warsh has something nice to say about Hayek:

That said, it is pleasing to think that Hayek himself may yet turn out to have been a very great economist after all, far more significant than Myrdal or Robinson, when seen against the background of a broader canvas.  The proposition that markets are fundamentally evolutionary mechanisms runs through Hayek’s work. Caldwell, of Duke University, notes that, starting with the Constitution of Liberty, “the twin ideas of evolution and spontaneous order” become prominent, especially the idea of cultural evolution, with its emphasis on rules, norms, and decentralization.

These are today lively concepts in laboratories and universities around the world. “It could have been that Hayek was running a different race, and the fact that he didn’t do well in the Walrasian race was that he wasn’t running in it—he was running in the complexity race,” says David Colander, of Middlebury College. Hayek may yet enter history as a prophet of evolutionary economics, a discipline dreamt of since the days of Thorstein Veblen and Alfred Marshall in the late nineteenth century but not yet forged, whose great days lie ahead.

Markets are evolutionary? I'll have to put that on my list of things to look into. That's a list that just keeps getting longer.

I can't say what Hayek meant by evolutionary markets, not what Warsh and the others mean by evolutionary economics. I can only say what I see:

The economy changes. It changes in response to policy. And it changes in response to internal imbalances and such. Exogenous and endogenous change.

If we lived as long as Struldbrugs we could see the big picture. But we don't. So we can see business cycles, but we can't see the ones that are a human-lifetime long or more, because we never get to see them repeat. And (not) seeing is (not) believing.

And this process of change... Looking at it from afar, it looks like cycles. But looking at it the way we get to look at it, it only looks like "evolution".

That's about it.

"Money and Social Possibilities"

An interesting post I disagree with, at heteconomist.com.

Before the "so"

Found this nicely organized site, with a bit of British flavor in the writing -- the Virtual Worlds section of Biz/Ed.

I have not figured out yet how to get from the home page to the page Google got me to. So I will skip over the niceties and get to the point.


From the Explanation of Interest Rate page:

The interest rate can be considered as the price of money.

It can be, but it shouldn't be. The interest rate is the price of credit, the price of using OPM, other people's money. Somebody said "OPM" back in the early '90s in one of the newsgroups, at 2400 baud, whatever -- long ago -- and those three letters stuck in my head. Useful.

That's from Milton Friedman, by the way: The interest rate is the price of credit.

Here's the rest of that first paragraph:

If you want to borrow money [the interest rate] is the percentage over and above the original loan that has to be paid back. This makes the interest rate a vital tool of economic management. A large amount of economic activity (both consumption and investment) is done on borrowed money, and so if the interest rate is changed it will either encourage or discourage borrowing and therefore tend to increase or decrease economic growth.

Know what gets me? These words:

A large amount of economic activity is done on borrowed money

Oh -- I don't deny it, not at all.

I object to taking that phrase and burying it before a comma and before the word "so". I object to taking that fact and treating it as a given, treating it as the type of fact that always has been and always shall be, world without end Amen. That's what I object to.

Sloppy it is. Even when the reliance on credit was low, you could easily say "a large amount of economic activity is done on borrowed money". Sure, and it would be true, too. HOWEVER...

The reliance on credit varies.

Sometimes, the large amount is about equal to GDP. Sometimes it is three times GDP or more. Sometimes the large amount is five times the amount of money we don't have to pay back. Sometimes the large amount is 35 times that money. The reliance on credit varies, and economic performance varies as a result.

Bury the Virtual Worlds phrase before the "so"... or insist that money and credit are the same thing... and you will never be able to understand the effect of varying the reliance on credit. The effect on the economy as a whole. The effect on economic performance.

The solution to the problem we cannot solve will be found in the place we do not look.

Long Trends in Monetary Phenomena

On what basis, then, do the Kondratieffites presume to bracket 1940 with 1896 and 1849 and 1789 as the terrible years of Kondratieff troughs? Really, on one and only one ground: each of these years was a trough point for the index of wholesale prices. All the other alleged confirmations of the Kondratieff troughs were simply of prices, or else of monetary phenomena reflected in prices.

-- Rothbard

Three long data series are shown on Graph #1: Robert Shiller's interest rate (in black), my debt-per-dollar (in red), and a 5-year moving average of the "real" interest rate (in blue). The blue is the one that makes the graph look crazy with all its ups and downs, despite being averaged. The black line shows the three peaks that I identify as three longwave peaks. The red DPD starts later, and shows only two peaks.

The red is composed of two separate lines actually, because I have two mis-matched sources for debt numbers: Historical Statistics (1916-1970) and FRED (1959-2010). (You can see the same mis-match in Krugman.) Also, the red one is scaled down by half to bring it near the black and blue, for comparison.

Graph #1

The blue (real interest) line trends downward from the first black peak (1873) to the first black trough (1900). Black and blue then move upward together (if we ignore the exogenous "V" around the time of the First World War). Then black peaks (1921) and starts to fall, while blue continues to rise. Blue finally peaks with red (1931, 1933), then together these fall. (I second-thought this late peak, below)

Everything reaches a bottom together around 1946, then all begin to move upward.

Similar to the exogenous "V" of the First World War is an exogenous blue "U" from 1939 to 1951, bottoming in '46 and quite evidently related to the Second World War.

I think I see a third (exogenous?) anomaly from the mid-1960s to the early 1980s, caused by the high inflation of that period. If that is the case, I think the natural trend of the blue line would follow the red line from say 1962 to 1982.

After the black and blue peaks (1982, 1984), both interest rate lines trend downward -- just as they did from 1873 to 1900. But not as they did after the second black peak in 1921.

Now I am wondering about the blue peak at 1931. In 1928 the blue line is still on the downward path of 1923-1937. After 1937, war created an anomalous low. Perhaps after 1928, Depression created an anomalous high?

Yes, that makes sense: the blue line differs from the black by the rate of inflation. Three high periods of inflation -- WWI, WWII, and the seventies -- created three anomalous lows. And the one period of extreme deflation -- the Great Depression -- created an anomalous high.

If that is the case, and if we ignore the anomalies, perhaps there is a natural downward trend from 1923 to perhaps the mid-1940s. This would correspond to the earlier decline pattern (following 1873) and to the later decline pattern (following 1982).

I know, there is a lot of "if" in this analysis.


Treating the blue peak at 1931 as an inflation-related anomaly (rather than as trend), we are left with a blue line that runs up and down in a pattern much like the black: real and nominal interest rates moving together, except for episodes of high inflation or high deflation. Makes sense, I think.

Granted, there are almost as many anomaly years as normal-trend years.


The period between the peaking of interest rates and the peaking of debt-per-dollar is a period of financial euphoria.



There is a lot of "if" in the above analysis. Does that weaken my case?

Perhaps. But I think it weaken it less to say (as I say) that these unique events disturb the pattern, than it does to say (as Rothbard says) that these events create the pattern.

I agree with Rothbard that government actions sometimes create disturbances. When I look at my graphs, I can see those disturbances. But I also see a natural wavelike pattern only temporarily disturbed. And after each disturbance I see rapid return to the wavelike pattern. The First World War, for example, created a sharp drop in real interest rates. But after the war, the real interest rate trend returned to the pattern it showed before the war!

The disturbance in every case is a price disturbance.

The natural pattern itself arises from the accumulation of financial cost and the accumulation of financial wealth. These accumulations are monetary phenomena: imbalances, sometimes so severe that they topple governments.

EGADS!

http://news.research.stlouisfed.org/2011/12/new-fred-category-structure/

New FRED Category Structure

We will soon be reorganizing the categories in our FRED database. During this process, users will still be able to access and search for all series.

After these modifications, FRED will have 7 main categories:

National Accounts
Population, Employment, and Labor Markets
Production and Business Activity
Prices
Money, Banking, and Finance
International Data
U.S. Regional Data

Several existing categories will be eliminated, and series listed under those categories will be moved to more descriptive categories. All email notifications for the eliminated categories will be updated. For more clarification, see the mockup of the changes. We intend to complete this transformation by the end of this year.

TFA (suffix)

From yesterday:

Graph #1: Components of "Total Financial Assets"

I'm wondering what the red line would look like if we separated household assets from the assets of nonprofit organizations.

I went to FRED and did a search for balance sheet of households. FRED turned up a list of 47 data series. Every one of those series descriptions ends with the phrase "balance sheet of households and nonprofit organizations". Sometimes the information you're looking for just isn't so easy to find.

Reminds me of looking for data series on private debt.

TFA

Found "Total Financial Assets" at FRED by accident just now.

Graph #1: Components of "Total Financial Assets"

Red: Household and Nonprofit Organizations
Blue: Nonfarm Nonfinancial Corporate business
Green: Nonfarm Noncorporate Business

Omitted are farm assets. Of course: Economists sure don't like them farmers. Also omitted: Financial business. I'm sure there's a good reason for that, too. And also the government. Perhaps because government "cannot save"...

I'm wondering what the red line would look like if we separated household assets from the assets of nonprofit organizations. ("Nonprofit" doesn't mean they don't make money. It just means they don't pay income tax on the money that they make.)


I added up the three components of TFA and showed the total in blue on a new graph:

Graph #2: Total Financial Assets (blue) and TCMDO (red)

What to compare it to? First thing that came to mind was TCMDO, Total Credit Market Debt Owed.


The distance between the lines was greater than I expected. So I tweaked TCMDO by taking out Federal debt held by the public, and adding in Gross Federal debt. The latter is a bigger number, and should make the red line closer to the blue.

Graph #3: TFA and (TCMDO less Net Federal plus Gross Federal debt)

Quite a bit closer. I suppose the difference includes farm assets. And foreign holdings maybe. Getting out of my depth, here.


But I was running out of interesting things to do with TFA. So I logged it:

Graph #4: Same as Graph #3 but on a log scale

Now I have something to say.

Just an impression, really. Looks like the closer the lines are to each other, the worse the economic performance. The bigger the spread, the better.

The lines were far apart in the 1950s and '60s, during the Golden Age. The lines came closer together during the troubled 1970s. After a brief separation in the early 1980s, the lines ran close together until the mid-1990s. During the Macroeconomic Miracle of the latter 1990s, the gap opened up again.

Then the gap collapsed completely, in two steps, in the 2000s.

Like I said, out of my depth. But I'm wondering if there is some relation between this gap-related behavior and the thing that is often called Net Financial Assets.

You pays your money...

...or you saves it.

Second graph from yesterday:

Graph #1: Savings relative to Circulatings, 1915-1932

Here's the picture through 1936, the year Keynes published his General Theory:

Graph #2: Savings relative to Circulatings, 1915-1936

Here's how the picture looks through 1945, the year Franklin D. Roosevelt died:

Graph #3: Savings relative to Circulatings, 1915-1945

Here's how it looks for the full data available in the Historical Statistics, 1915-1970:

Graph #4: Savings relative to Circulatings, 1915-1970

Here's how it looks after combining Graph #3 with the numbers from FRED:

Graph #5: Savings relative to Circulatings, 1915-2010

Pretty good mis-match between the old and new numbers, but I can't help that.

The black line and gray shading way down low on Graph #4 show the same numbers as Graph #3, in proportion to the FRED numbers.

Those four FRED lines -- blue, red, green, and orange -- follow the same color scheme as the first graph from yesterday. Which one to use? Your choice. They all go up.


One of the big problems with policy is that it encourages savings. We think it wise to find ways to "enrich" people by enabling them to pile up claims to enjoyment without them ever intending to enjoy those claims.

That sharp decline

From me, from yesterday:

Savings relative to circulatings:

Graph #1: Starts low. Ends high.

Looking at the red line, non-circulating MZM grows from equal to M1, to five times M1 by 2007, when a sharp decline sets in.

I'm using 2007 as the-peak-before-the crisis. Our Great Recession started late in 2007. I'm setting up 2007 as comparable to 1929. The Great Depression started late in 1929.

The first year that I have M1 and M2 money numbers for is 1915, 18 years before 1929. 18 years before 2007 is 1993. That's where my graphs will start, 1915 and 1993.

The last year that I have M1 and M2 money numbers for is 2010, three years after 2007. Three years after 1929 is 1932. That's where my graphs will end.

I give you "Savings relative to Circulatings" for the two comparable periods 1915-1932 and 1993-2010:

Graph #2

Graph #3

Just at the end there... See that sharp decline?

Piling up claims to enjoyment

From Keynes, from yesterday:

...the maxims which are best calculated to "enrich" an individual by enabling him to pile up claims to enjoyment which he does not intend to exercise at any definite time.

Savings relative to circulatings:

Graph #1: Starts low. Ends high.

Blue is M2, red is MZM, green is M3, in each case with circulating money (M1) subtracted from it, and the difference shown as a multiple of circulating money.

And, for comparison, the orange line is total debt (TCMDO) with "circulating" money MZM subtracted from it, and the difference shown as a multiple of MZM.

Looking at the red line, non-circulating MZM grows from equal to M1 in 1959, to five times M1 by 2007, when a sharp decline sets in. A five-fold increase.

These non-circulatings are all of them measures of the claims to enjoyment that are not intended to be exercised at any definite time. In other words, they are measures of the absence of aggregate demand.

Our economic policies for the period shown on the graph have propped up aggregate demand by increasing various measures of money, and simultaneously undermined aggregate demand by increasing various encouragements to take those dollars out of circulation, and save them.

The Marginal Propensity to Consume

I'm a slow reader. I don't do well with books like  A Game of Thrones. But my pace helps a lot when I'm in The General Theory. My recommendation: Read the excerpt slowly and enjoy it. Keynes is wonderful.

From the conclusion of Chapter 10, TGT:

Ancient Egypt was doubly fortunate, and doubtless owed to this its fabled wealth, in that it possessed two activities, namely, pyramid-building as well as the search for the precious metals, the fruits of which, since they could not serve the needs of man by being consumed, did not stale with abundance. The Middle Ages built cathedrals and sang dirges. Two pyramids, two masses for the dead, are twice as good as one; but not so two railways from London to York.

Thus we are so sensible, have schooled ourselves to so close a semblance of prudent financiers, taking careful thought before we add to the "financial" burdens of posterity by building them houses to live in, that we have no such easy escape from the sufferings of unemployment. We have to accept them as an inevitable result of applying to the conduct of the State the maxims which are best calculated to "enrich" an individual by enabling him to pile up claims to enjoyment which he does not intend to exercise at any definite time.

Your mind wandered, didn't it. Start over and read slowly.

Two of a kind

I never get enough of quoting Robert Lucas in his Irving Fisher moment...

macroeconomics in this original sense has succeeded: Its central problem of depression-prevention has been solved

...even when I'm feeling just a tad guilty for focusing so much on one guy. So I want to take this opportunity to share a similar quote from second economist.

In his Economics textbook, fourth edition (1958), Paul Samuelson imagines the words of a brave and careful economist of the day:

Everywhere in the free world governments and Central Banks have shown they can win the battle of the slump.

"But let us not be too arrogant," Samuelson warns:

The difference will be this: the age-old tendencies for the system to fluctuate will still be there, but no longer will the world let them snowball into vast depressions or into galloping inflations.

Sounds like: "The central problem of depression prevention has been solved."