Thursday, August 25, 2011

Iffy, Piffy

Clonal introduced me to the notion of inflation-adjusted debt in comments here:

If I look at "real" cpi adj. household debt per civilian worker, I get an interesting chart... At the peak, the average worker was in debt for about 18 months of pre tax earnings or 24 months of after tax earnings...

Clonal's chart:

Graph #1: Real Household Debt per Civilian Worker

This was something more than five weeks ago. At the time, I didn't see validity in the idea of dividing inflation out of debt numbers. But the idea comes back to me now.

It is certainly reasonable to strip the price changes out of GDP and look at the inflation-adjusted numbers. It is not reasonable to apply the word "real" to the result. And it is not reasonable to use that result as the denominator of a ratio that you then compare to the trend of prices, as Milton Friedman has done. But it is reasonable to look at the numbers for inflation-adjusted GDP, because that is a good way to see whether the economy is growing, and by how much.

Likewise, it is reasonable to look at the inflation-adjusted "consumer spending" component of GDP, or the inflation-adjusted investment component, or the inflation-adjusted government spending component. It is okay to look at any of these, to see the growth of that component.

If it is reasonable to look at the inflation-adjusted Federal spending component of GDP, then it must be okay to look at the entire lump of inflation-adjusted Federal spending, or any part of it.

So then it must be reasonable to look at the Federal deficits after inflation adjustment. This would be a good way to determine whether and by how much those deficits have grown, after allowance for inflation.

Now, what if I take those deficits and add them together? Is that okay? Adding up inflation-adjusted deficits would give me inflation-adjusted debt. That's why I ask.

I remember seeing notes (in the Statistical Abstract, perhaps) about "chained" GDP values, that it is not valid to add the values together. (I had the impression that a problem arose from the "chaining" method, but the reason was not given.) Is there some trouble that arises from adding inflation-adjusted values? I have no answer at this time.

I am going to assume the addition is okay, as long as the purpose is to observe growth. So now, I will take a short cut. Rather than inflation-adjusting all the deficits and adding them up, I will just take the Gross Federal Debt and adjust that:

Graph #1: Inflation-Adjusted Gross Federal Debt

This graph shows that before about 1981 the growth of the Federal debt kept pace with inflation, and since that time the growth of the Federal debt has far exceeded inflation. The change is surprisingly distinct.

If the Federal debt only keeps up with inflation, then the debt is not excessive. By this measure, until 1981 the Federal debt was certainly not excessive.

I have an answer now, regarding the validity of inflation-adjusted debt graphs. It is essentially the same thing I said about the Stan graphs: I'm not dividing inflation out of accumulating debt. I'm comparing debt to the price level.

That is a reasonable thing to do, certainly, if you're interested in such things. Is debt increasing as fast as prices? Faster? Or slower? These are very good questions.

I also have an answer regarding Milton Friedman's error.

If I divide something by a price deflator, I'm making a legitimate comparison. But if I take the resulting number and use it in another calculation, I am pretending to have divided inflation out of the original something. This pretense is Friedman's error.

No comments: