Sunday, September 30, 2012


During the pre-game, one of the former coaches says, "Winning the game will do wonders for their confidence."

It's true. Even a good team has bad days and even a bad team has good days. The team that comes in confident has a real advantage.

But there is more to the game than confidence.

Market Monetarists believe that the way monetary policy works, and the way it should work, is primarily by expectations...

But there is more to the game than expectations.

Unfortunately, he was not referring to private debt

John Cochrane, Thursday, September 20, 2012:

I agree with the conclusion (high debt is likely to cause low growth).

Saturday, September 29, 2012

The Conscience of an Evolving Liberal

1. 6/28/2010 4:18:11 AM: Inequality and Crises (PDF):

Pre-2008: When I would talk to lay audiences about inequality, I would mention that we were reaching levels not seen since 1929 – and that would inevitably lead to questions about whether we would soon have another Depression. No, I’d say – there really isn’t a clear reason why high inequality should lead to macroeconomic crisis.

2. September 22, 2012: Inequality Kills

Kathleen Geier makes a point I should have noticed. She points to the shocking story in yesterday’s Times about sharply declining life expectancies for less-educated whites, and points out that these declines took place at a time of rapidly rising income inequality...

In any case, Geier is surely right: what we’re looking at is a clear demonstration of the fact that high inequality isn’t just unfair, it kills.

Friday, September 28, 2012

(One of) The Problem(s) with Expectations

Nick Rowe is good, but:
...the Short Run Phillips Curve. If the SRPC is (believed to be) steep, an increase in (expected future) NGDP will mean a large increase in (expected) inflation and a small increase in (expected) real growth. If the SRPC is (believed to be) flat, an increase in (expected future) NGDP will mean a small increase in (expected) inflation and a large increase in (expected) real growth.


Thursday, September 27, 2012

No Matter What the Red Line Does

The black line is prices.

Multiply the red line by prices, and you get the blue line.

The blue line is similar to the black line. Similar to prices.

"Of course it is," you say. "That's what happens when you multiply by prices."

Well yes, of course it is. But dividing something by "real output" is just another way to multiply by prices. Surreptitiously. It is this multiplying by prices, in my first graph, that makes Federal Spending relative to output look similar to prices. It is this that makes labor cost look similar to prices. And it is this that makes Milton Friedman's "money relative to output" look similar to prices.

1. The red line is Federal spending as a percent of GDP. The blue has prices factored in:

Graph 1: The blue line is very similar to prices

2. The red line is total labor cost as a percent of GDP (Index 2005=100). The blue has prices factored in:

Graph #2: The blue line is very similar to prices

3. The red line is M2 money as a percent of GDP. The blue has prices factored in:

Graph #3: The blue line is similar to prices

Of the three graphs, it appears that Friedman's "money relative to output" shows the least similarity to prices. Friedman's evidence is the weakest of the three.

Of course, it isn't evidence at all, really. It is only the surreptitious factoring-in of prices.

Rule #2: If "real output" is in the denominator, reject first and ask questions later.

Codecogs, FRED, and Policy

I just found the Online LaTeX Equation Editor at CodeCogs.

There are reasons *NOT* to count money in savings when you figure the Velocity of money. For example, it is not in the spending stream.

But there are also reasons *TO* count the money in savings when you figure the Velocity of money. At the whim of the saver, for example, savings can move back into the spending stream.

Okay, so both M1 Velocity and M2 Velocity are important.

Right away then, I want to look at the ratio between them:

Oh, but that expands to this:

And that is the same as this:

And that reduces to this:

Okay. Let's look at that:

Graph #1: Circulating Money as a Portion of the Money Stock M2

When I was young, half (0.50) of M2 money was circulating. (In the 1950s, more than half was circulating.) Circulating money is the money we receive as income, and spend.

The circulating quantity fell, essentially uninterrupted until the mid-1980s. Then, an increase in two steps opened the door to the brief time that Robert J. Gordon called a "macroeconomic miracle" -- the good years of the latter 1990s.

Note that the ratio fell during those good years, just as it fell during the "golden age" which ended in 1966.

Note that the ratio continued to fall after the end of the "miracle" years, and after the end of the "golden" years. Policy encouraged or allowed these declines to continue when they were no longer helpful to economic performance.

Circulating money continued to fall until the Fed responded to the financial crisis.

Wednesday, September 26, 2012

The Fraudulent Use of Arithmetic

Just about a year ago I considered a post by Steve Randy Waldman:
I need another look at Steve Waldman's interesting layout of our economic problem:

"Prior to the 1980s, the marginal unit of CPI was purchased from wages... Prior to the 1980s, central bankers routinely had to choose between inflation or recession."

Then came the “Great Moderation”. The signal fact of the Great Moderation was that the marginal unit of CPI was purchased from asset-related wealth and consumer credit rather than from wages.

So in this view, the policy-change was a change from intermittent wage-suppression to continuous wage-suppression. It's a tidy thought, but that doesn't make it right.

I do not accept Waldman's tidy analysis. The Federal Reserve does not manage wages.

What Waldman was saying just didn't make sense to me, despite several attempts by himself and myself to make it make sense to me.

Time goes by.

My recent "Symmetry in Deception" series drawing to a close the other day, I Googled unit labor costs and turned up interfluidity » Restraining unit labor costs is a right-wing conspiracy, from half a year back.

Waldman opens thus:
In an otherwise excellent post, Matt Yglesias commits one of the deadly sins of monetary policy:

[M]y favorite indicator of inflation is “unit labor costs”… Unit labor costs are basically wages divided [by] productivity. It’s not the price of labor, in other words, but the price of labor output. If productivity is rising faster than wages, then even if wages themselves are rising unit labor costs are falling. Conversely, if wages rise faster than productivity than unit labor costs are going up...
That all sounds reasonable. But Yglesias has fallen into a trap. Unit labor costs are not “basically wages divided [by] productivity”. That’s not the right definition at all. Unit labor costs are nominal wages per unit of output. With a little bit of math, it’s easy to show that
An increase in unit labor costs can mean one of two things. It can reflect an increase in the price level — inflation — or it can reflect an increase in labor’s share of output.

I've omitted Waldman's "update", where he acknowledges that something like Yglesias's definition of Unit Labor Cost -- a one hour's wage version, I think -- may be correct.

Update omitted, Waldman's definition of ULC agrees with the YourDictionary definition, and with the OECD's definition. And with my definition, as created by YourDictionary and confirmed by OECD.

(Waldman refers to "nominal wages" as labor share. My accepted sources refer to total labor cost, or wages plus benefits, let us say. The confusion here is the same confusion described in Wikipedia: Compensation of employees, which I noted here. But Waldman is close enough, for now. That discrepancy is not my topic.)

Waldman writes: Unit labor costs are nominal wages per unit of output. "Nominal" means "at the prices actually paid, inflating though they be". "Output" is GDP with caveats: Often, the word "output" is used to mean "real output" or "real GDP" or "figured at prices that have been reduced to remove the effects of inflation". All too often, with the effects of inflation surreptitiously removed. Waldman points it out.

By Waldman's definition (and mine) Unit Labor Cost divides an inflating quantity by an inflation-adjusted quantity. Division by an inflation-adjusted quantity is a back-door, sneaky, deceptive way to bring inflation *INTO* the result of the calculation. Waldman points this out, too:


It is a very big deal.

Rule #1: Always be wary of the word "output". It is often found in bad arithmetic.

Waldman looks at his formula, notices that two things (the price level thing, and the labor share thing) go into Unit Labor Cost, and translates the math into English:

An increase in unit labor costs can mean one of two things. It can reflect an increase in the price level — inflation — or it can reflect an increase in labor’s share of output.


But. Let me ask you this: What is Unit Labor Cost used for? Easy answer, just recall what Yglesias said, as quoted by Waldman:

[M]y favorite indicator of inflation is “unit labor costs”

Unit Labor Cost is used as an indicator of inflation.


Multiply inflation into Labor Share of Output, use the resulting numbers as an indicator of inflation, and when you see inflation in the numbers, blame Labor Share.

Again: Multiply inflation into the Labor number, feign to discover a similarity between inflation and the resulting number, and blame the Labor number for inflation!

Used in the denominator, the calculated value called "real output" -- often simply called "output" -- surreptitiously creates the appearance of similarity between inflation and the labor number. Refer to Rule #1.

Waldman's Unit Labor Cost post isn't really about ULC. Really, it is about the Fed's "direct suppression of labor’s share" -- same as his post that I reviewed a year ago. Funny thing is, in this post that made sense to me. This part sums it up:

For labor’s share to expand, either the price level must fall, or unit labor costs must rise faster than the price level. But the Fed responds aggressively to rising unit labor costs, and is committed to preventing any decrease in the price level. Under this policy regime, expansions in labor’s share are pretty difficult to come by!


Okay. But now that I've belatedly agreed with Steve Randy Waldman about the suppression of labor's share, now I feel free to disagree with him over ULC.

Waldman finds a bad definition of Unit Labor Cost, corrects the definition, and then evaluates it. Given that there are two factors (prices and labor's share) that go into ULC, Waldman expresses the relation clearly: "An increase in unit labor costs can mean one of two things..."

Yes, and I don't deny it. Given the formula for Unit Labor Cost, Waldman reaches the only conclusion that can reasonably be reached.

This is where I disagree with Waldman: Given the Unit Labor Cost formula, Waldman accepts that formula. I do not.

Waldman thinks of the ULC as economics to be evaluated. I see it as bad arithmetic, to be dismissed.

If the formula// no, wait.

We don't accept or reject formulas because we think they produce results we like or don't like. Rather, formulas are either valid or not, on their own merits.

If the formula is valid, we must accept it.

If the formula is not valid, we must not accept it.

The Unit Labor Cost formula is not valid -- not when ULC is used as an indicator of inflation. It is not valid because inflation is factored into the ULC numbers. On a graph, ULC appears similar to inflation because inflation is factored into the numbers. Any comparison of ULC to inflation is a fraudulent use of arithmetic.

The Unit Labor Cost formula factors the price trend into its results and allows us to discover that the results show similarity to the price trend. The logic is circular. The logic is not valid. The formula must be rejected.

Rule #2: If "real output" is in the denominator, reject first and ask questions later.

The Lie

What's Wrong with this Picture?

Graph #1: Federal Spending Relative to Output

Hint: It uses "real output" in the denominator.

My sense of humor is a little off from the rest of the world. I'd best not leave it at that. Federal spending was not really so small, in the early years shown. Nor did it increase so rapidly in the years since.

Graph #1 is not the honest picture of "Federal Spending Relative to GDP". The honest picture shows Federal spending increasing, but nowhere near as much as on Graph #1. The honest picture is the red line in Graph #2, below:

Graph #2: The Blue Line is the Red Line with Prices Multiplied In

Graph #2 shows the same data as Graph #1 (blue, again) plus the honest picture (red). The red line does not use the "cheat" that I've been talking about for the past week. The blue line uses the cheat.

The cheat is to use "real output" in the denominator. It makes the resulting numbers increase more rapidly than honest numbers, in a pattern that mimics inflation. That's what makes the blue line so up-sloping on these graphs, and so similar to the trend of prices:

Graph 3: The Black Line is Prices. The Blue Line is the Cheat

The same cheat displayed in these three graphs is typically used in "Money relative to output" graphs and in "Unit Labor Cost" graphs. In all three cases, what seems to be a shocking increase is really just an outrageous lie.

Federal Expenditures: "Current" and "Total"

Point of interest.

Blue line: "total" expenditures.
Red line: "current" expenditures.
Not sure what the difference is, but it isn't much.

On the right scale, the green line shows current expenditures as a percent of total. Generally between 96% and 100%, since the late 1960s anyway.

So now I feel better about the validity of graphs that make use of "current" expenditures. It is almost the same number as "total" Federal expenditures.

p.s. I'm not sure what it means when "current" expenditures are more than 100% of "total" expenditures. Not sure how that can happen.

Tuesday, September 25, 2012

"wages and benefits were almost keeping up with inflation"

Looking at this mathematical deception graph...

Graph #1: Unit Labor Cost (blue) and the Implicit Price Deflator (red)
(Click graph for the FRED source page)

...Jerry said:

I think all this shows is that wages and benefits were almost keeping up with inflation.

How to tell? Put the two number series into one line!

Graph #2: Unit Labor Cost less GDP Deflator (Index 2005=100)


Graph #1 shows two "index" series, both using 2005=100 so the lines cross at that point . I subtracted the red line from the blue -- I subtracted the price deflator from Unit Labor Cost, to see if wages and benefits were keeping up with inflation. Graph #2 shows the result.

Neck-and-neck until 1965.

Wages and benefits made gains during the Great Inflation (1965-1982).

Wages and benefits lost out to prices since the 1982 recession.

But that's based on the GDP Deflator. Maybe I should use the Consumer Price Index because we're looking at the wages and benefits of consumers.

I re-did Graph #1, this time showing Unit Labor Cost (blue) and the CPI (red). I tweaked the CPI so it has the value 100 in 2005 (same as ULC and the Deflator). And in green I added the "difference" line, like the one on Graph #2.

Graph #3: Comparing Unit Labor Cost and the CPI

(Added 100 to the green line, so that all three lines cross at 2005.)

The green line, the difference line, shows some slight gain for wages and benefits in the 1950s. It shows  wage and benefit gains during the Great Inflation, like Graph #2. And like Graph #2, wages and benefits lose out to prices since the 1982 recession.

"Almost keeping up" with inflation? Depends how you define "almost"!

Fake Output

They add up all the stuff we produce in a year, at the prices we paid to buy it, and they call it "nominal" output.

Then they take all the price changes out of that number and of GDP numbers for other years, so it is like there was no inflation. And they call these numbers "real" output.

This thing they call "real" output is useful for looking at changes in the volume of production, as opposed to changes in prices.

It is also useful for faking evidence to support bad arguments.

From now on, let's not call it "real output". Let's call it fake output.

Monday, September 24, 2012

Symmetry in Deception: Similarities between "Unit Labor Cost" and "Money Relative to Output"

Consider the mathematical deception entangled in the "Unit Labor Cost" (ULC) calculation, and in the comparison of "money relative to output" (MRTO) to inflation. Both follow the same pattern:

1. Divide GDP by a price index to get a fraction called "real" GDP.
2. Use this fraction as the denominator of another fraction.
3. Compare the result to inflation, and find similarity.

The MRTO uses this formula: (M2) / (GDP/Prices)
The ULC uses this formula: (Total Labor Cost) / (GDP/Prices)

In both cases we divide by the fraction (GDP/Prices). The schoolboy's rule "To divide by a fraction, invert and multiply" tells us that:

The MRTO calculation in fact is (M2 / GDP) * Prices
The ULC calculation in fact is (Total Labor Cost / GDP) * Prices

In both cases a ratio is multiplied by prices, and the resulting numbers climb upward on a path comparable to the path of prices. (For "Prices", both use the GDP Deflator.) Without multiplying by Prices, neither ratio is similar to the trend of prices.

Milton Friedman's "Money relative to output" graphs compare the quantity of money to the "real GDP" ratio, show similarity to inflation, and are used as evidence that printing money causes inflation.

The "Unit Labor Cost" calculation compares Total Labor Cost to the "real GDP" ratio, shows similarity to inflation, and is used as evidence that rising labor costs are the cause of inflation.

These are fraudulent uses of arithmetic, and are not acceptable.

Sunday, September 23, 2012

"This mathematical deception is guaranteed to make labor costs look as if they are increasing on a path similar to inflation."

I said it, but I didn't show you. So, here it is:

Similarity: Unit Labor Cost and the Implicit Price Deflator
(Click graph for the FRED source page)

The Unit Labor Cost series: Suspiciously similar to the Price Deflator, don't you think?

The Uses of Fake GDP (2): Unit Labor Cost

I looked at "Unit Labor Cost" the other day. According to, ULC is calculated as "total labor costs (including benefits)" divided by "real output".

Wikipedia has a problem with that. Under Compensation of Employees (CE) it says:

The main criticisms made of the accounting concept of CE are that it can make workers' incomes look larger than they truly are, and that the main components of CE are not separately itemised in the accounts. What CE really contains is not made explicit.

Often economists confuse CE with the total wage bill of a country, which is false. They might use CE to strike a quick "wages-profits ratio" or calculate unit labor costs, without realising what they are really doing. CE is not equal to gross wages, or real disposable income of workers, nor - strictly speaking - total labour costs.

I dunno. The OECD's definition pretty much agrees with

Unit labour costs (ULC) measure the average cost of labour per unit of output and are calculated as the ratio of total labour costs to real output.

OECD seems not to define "total labour cost" but does define Labour Cost:

Labour cost is defined as the total expenditure borne by employers in order to employ workers, a concept which has been adopted in the Community framework and complies broadly with the international definition of the International Conference of Labour Statisticians (Geneva, 1966).

Again, it seems to agree with And it seems to be "the total" labor cost. I think I have to dismiss the objections of the Wikipedia article.

Now about that calculation: Add up all the costs you can associate with labor, and divide it by GDP. Oh -- no, that's wrong. Divide it by real GDP.

So they take a cost number and an output number, make them into a ratio, and then reduce the denominator to account for inflation. The value of the ratio must therefore be skewed upward on an inflation-like path. That is a blatant falsification of the facts.

Why bother to divide inflation out of the denominator? Why not just multiply the ratio by inflation directly? You'd get the same result.

The Wikipedia article has all sorts of complaints about the calculation. But apart from economists' confusion, the main complaint seems to be that CE "can make workers' incomes look larger than they truly are".

Sheesh. If I try to get a job that pays $10 an hour, but the employer has to pay a total of, say, $25 an hour if they hire me, then $25 is the number that determines whether anyone gets hired. If you're concerned about employment -- or unemployment -- the total labor cost number is the number you have to watch.

The Wikipedia article is pretty bad. But it's almost right about one thing. Something is made to look larger than it really is. But it's not total labor cost. It is the ULC, the Unit Labor Cost, that is made to look falsely large. But this is not accomplished by counting the costs associated with labor.

It is accomplished by stripping inflation out of the denominator of the Unit Labor Cost calculation. This mathematical deception is guaranteed to make labor costs look as if they are increasing on a path similar to inflation. When the deception is not used, it is easy to see that Unit Labor Cost is falling and has been falling for half a century.

Saturday, September 22, 2012

At least he's honest about it

In Fedspeak NGDP portfolio, Nick Rowe talks about the things we don't know.

He says we don't know "the relative strengths" of the trade-off between "(expected) inflation" and "(expected) real growth".

He says we don't know the timing of the effects of an "increase in expected inflation".

He says, "We do not have a good theory of how short run supply shocks shift the [Short Run Phillips Curve]. And we do not know what short run supply shocks there will be..."

"If we did know" all those things, Rowe says, "We would know how much inflation would be associated with a higher level of NGDP".

"But we don't know," he adds.

Nick Rowe seems less concerned about finding out those things than he does about pushing the NGDP Targeting agenda:

"A higher NGDP target is like a portfolio of inflation and real growth, and when you are uncertain a portfolio of two assets is usually better than a single asset. Eggs and baskets stuff."

"An inflation target to escape the Zero Lower Bound seems like putting all your eggs in one basket."

"An NGDP target is more like putting half your eggs in the inflation basket and half your eggs in the real growth basket. One basket should work, even if the other fails."

I guess he's pushing the NGDP Targeting agenda. Doesn't sound like it, really.

"Expected inflation goes up, expected real interest rates go down, Aggregate Demand goes up, actual inflation goes up, and validates the increase in expected inflation. And real income goes up, maybe by just the right amount, or maybe too little, or maybe too much. It could be far too little, or far too much..."

"That's the best I can do, for now."

Nick and his NGDP Targeting compadres are not even in the right ballpark.

The problem is not that prices are too low. The problem is that growth is too slow. There is only one correct focus, and it is to understand the reason growth is slow.

For the record, as long as economists continue to dismiss out of hand the possibility that excessive private sector debt is the reason growth is slow, economists will continue to fail to understand slow growth. They will be able to say only things like "But we don't know" and "That's the best I can do".

The Uses of Fake GDP (1): Evidence of Inflation

All the graphs in this post are FRED graphs, because FRED graphs are trustworthy.

Graph #1 is my attempt to duplicate Figure 1 from Milton Friedman's book Money Mischief. The graph compares "money per unit of output" to a measure of prices that Friedman described as "the deflator implicit in computing real national income"1 for the United States. My measure of prices, the blue line on Graphs #1, 2, and 3, is the "Implicit Price Deflator" from FRED.

For "money" Friedman used "the total designated M2 in the United States". I have used M2NS (M2 money, not seasonally adjusted) from FRED. Finally, for "output" Milton Friedman used "real national income". I didn't find measures of National Income at FRED, so I am using "Real Gross Domestic Product", the FRED series GDPC1.

National Income is slightly less than Gross Domestic Product. GDP is slightly more than NI. Assuming the same deflator is used to remove price changes from National Income and GDP, "real GDP" is slightly more than "real national income". Dividing M2 money by real GDP gives a result that is slightly less than Friedman's result. My result is the red line on Graph #1.

On the graph you can see the red line is a bit lower than the blue line representing prices. A slightly higher result would have been a better match. You can applaud Friedman for selecting the number set that best shows that printing money causes inflation; or you can say he did a little fine-tuning by picking the version of output that gave him the best results.

Graph #1: Duplicating Milton Friedman's 'Money relative to Output' Graph

Graph #2: As above, with "real output" exploded into components

Graph #2 is identical to Graph #1. The only difference is in the second line of the blue border above the plot. I have replaced FRED's "real GDP" number series GDPC1 with the calculation that produces that series.

Where Graph #1's formula shows GDPC1, Graph #2 has (GDP/GDPDEF).

(Also I no longer multiply by 100 in the second formula on the top border of Graph #2, because I no longer need to compensate for the way GDPC1 was calculated.)

The red line on Graph #2 is identical to the red line on Graph #1. The (GDP/GDPDEF) calculation produces numbers identical to the series GDPC1. "Real GDP", its name notwithstanding, is calculated by taking GDP at actual prices and dividing it by the price numbers of GDPDEF.

Thus, when Friedman uses "real output" for his graph, he brings the price numbers into his results. Milton Friedman's graph uses the price series as a factor in the calculation that he compares to the price series. GDPDEF is in both lines in the blue border above the plot -- and in both lines plotted on the graph as well.

Does it matter? Yes, it matters very much. Milton Friedman faked it. If you take Graph #2 and change the second formula in that upper border by removing the price numbers, the red line changes significantly. All similarity to the blue line disappears. All similarity between "money relative to output" and the price level disappears:

Graph #3
Milton Friedman shows similarity between "money relative to output" and the price level. That similarity is artificial. It is a result of using a price series to create numbers, and then comparing those numbers to that price series.

He faked it.

Now let's do something different. Let's throw away the implicit price deflator. Let's make up a number series and pretend it is our price index. Let's see if we can create a "money relative to output" graph that shows similarity to the price index we made up.

There is a number series I like a lot. It is a measure of consumer debt, relative to Gross Domestic Product. I like it because it is easily recognizable. It has a face in it:

Graph #4: FPI, the Face Price Index

I will use this in place of GDPDEF.

I want to compare this blue line, the Fake Price Index, to the quantity of money relative to output. But this time, "fake" output. I intend to show that I can force "money relative to output" to look similar to my fake price numbers, by using my fake price numbers in the calculation of the "money relative to output" numbers.

Where before we saw GDPDEF in the formula, now we will see (CMDEBT/GDP).

As Milton Friedman did, I divide the quantity of money by fake output and compare the result to the price index used to calculate that output, looking for similarity:

Graph #5: Faking the Friedman Graph
Not bad! The red line does go high at the end, when debt was going up like crazy. But other than that, the red line fits the blue very well. As Milton Friedman might have said, it shows a lot of similarity.

The trick to making one number series similar to another is to make the one series part of the calculation of the other. To do that is cheating, of course, if you then claim that the similarity is evidence of something. To avoid being called a cheater, it is essential to hide the cheating.

One can for example bury the offending number series by dividing it into another series and giving that ratio a name. This would give the impression that the ratio is not, in fact, a ratio but is itself an independent series.

Then, to solidify the impression you create by this deception, you must choose a name for that ratio carefully. Choosing a name like "fake" might make people question your work. It is wiser, perhaps, choose a name like "real".


1. From a footnote in Chapter 8: The Cause and Cure of Inflation in Money Mischief by Milton Friedman. This is the footnote:

That word "extrapolated" bothers me. It means he made up the numbers after 1975.

Friday, September 21, 2012

Velocity and Other Funny Things

Two kids behind a fence

When I go to FRED and type velocity in the search box, this is what I get:

Sorted by popularity (default), M2 Velocity is first on the list.

This, then, is "Velocity":

Graph #1: The Velocity of M2 Money
Velocity is a measure of how fast money moves. Something like that. A measure of how often the average dollar is spent. But not just any dollar, and not just any spending. It is a measure of how often M2 money is used for final spending.

M2 money is like the tall kid behind the fence, but just the part you can see. Funny thing is, the short kid is M1 money, which is the money people spend. M2 money is the money we have in savings and the money we spend, all added together. The Velocity graph -- which supposedly shows how fast the average dollar is spent -- is based largely on money we don't even spend. On savings. Meanwhile, behind the fence, from the eyeballs down, is other money -- money not included in the Velocity calculation, whether we spend it or not.

The standard calculation for how often the average dollar is spent assumes that money in the spending stream and money in savings are spent alike -- but only a portion of that money is used in to figure Velocity. The rest is behind a fence.

Come to think of it, the other number, the spending used in the Velocity calculation is also behind a fence. The standard calculation uses final spending, but excludes intermediate spending behind some other fence.

And that, ladies and gentlemen, is Velocity. The ratio of two numbers behind fences.

Economists depend on it.

If you take the Velocity graph and invert it, it looks like this:

Graph #2: Inverted Velocity
No no, that's not right. It looks like this:

Graph #2: Inverted Velocity

To invert Velocity, divide the value 1 by the Velocity number.

Funny thing. Velocity is GDP divided by M2. Velocity is a fraction. When we divide 1 by Velocity we are dividing by a fraction. For me, this brings back memories of grade school math: To divide by a fraction, invert and multiply.

To calculate 1 divided by V, calculate 1 multiplied by 1/V.

But maybe it makes more sense this way: V is the fraction GDP/M2. To divide by the fraction GDP/M2, invert and multiply. So to calculate 1/(GDP/M2), figure it as 1 multiplied by (M2/GDP). The answer is M2/GDP.

Oh yeah, the funny thing: M2/GDP is the same as "the quantity of money divided by output." Perhaps you've heard of that one. Milton Friedman made it famous.

Friedman wrote:

"Changes in the quantity of money have important, and broadly predictable, economic effects. Long-period changes in the quantity of money relative to output determine the secular behavior of prices."

Definitive, don't you think? But when you compare prices (the red line) to M2/GDP, it's hard to see any similarity at all:

Graph #3: Money Relative to Output, and Prices

Isn't that funny?

Thursday, September 20, 2012

Oh, well

The Related-Posts Menu works great in Firefox.
Not so much in (wouldn't you know it) Internet Explorer.

That's Final!

"Final spending" is a technical term. "Final" as opposed to "intermediate" spending. "Intermediate" spending is separated from "final" to avoid double-counting income.

If you go to the Mall and buy something for $10, that $10 is final spending. But when the store bought the thing, and when the shipper shipped it, and when the packer packed it, and when the manufacturer manufactured it, and when the engineer engineered it, and when the entrepreneur thought it up, none of the spending on it they did then was final spending.

Actually, each of them spent something on it, and each of them made something on it. If you take what they made on it, and subtract out what they spent on it, what's left is their income. And if you take all their income for the work on the thing you bought, and add up all that income, you get $10 of income. Exactly the same as the $10 you spent, the "final" spending.

Wednesday, September 19, 2012

"Real" output is calculated, not measured

Real GDP cannot be measured. It must be calculated.

I found a great statement to that effect from Statistics Canada. It's got a technical tone to it, but the meaning is clear:

Growth in the gross domestic product (GDP) or any other nominal value aggregate can be decomposed into two elements: a "price effect", or the part of the growth linked to inflation, and a "volume effect", which covers the change in quantities, quality and composition of the aggregate. The volume effect is presented in the National Accounts by what is referred to as the "real" series (such as the real GDP).

Statistics Canada uses the chain Fisher index as a measure of real GDP. Following the same sequence that we used with Equation (4), chaining Equation (6) gives us:

(7) Equation 7 - Fisher quantity index, chained
This is the formula used as the basis of the calculations of real GDP at both the national and provincial levels.

In case you were wondering.

Tuesday, September 18, 2012

Capacity Utilization: a new low in high points

Some 19 months ago I highlighted the high points on a Capacity Utilization graph:

Graph #1

I happened to look at the current version of that graph just now:

Graph #2

It looks like we've reached a new low in high points for Capacity Utilization. Looks like it's peaking below 80% this time.

// Update: I put a red circle on the important spot on Graph #2.

Daniel Kuehn versus Sumnerica

At Facts & other stubborn things, Daniel Kuehn writes:

Sumner's critique meshes together policy goals with actual policies so that evaluations of whether a policy (say, "looser money") is simply being pursued is treated synonymously with whether a goal we all like (say, "NGDP back to target levels") has been achieved.

...for market monetarists like Scott Sumner, who seem interested in going beyond decision rules and actually offering an analytic claim, there seems to be no way to logically make the statement "we have done the market monetarist policy rule and the goal was not achieved". Why? Because if NGDP level targets have not been reached then by definition you haven't been doing market monetarist policy.

It's one thing to say that different economic conditions call for different rates and base money supplies, and to note the difference between a nominal and real rate. It's another thing entirely to say that rates and the base should be ignored and that we should focus our attention on NGDP as a measure of the policy stance, because the whole scientific question at hand is "how does monetary policy (OMOs that affect the base and short rates and maybe long rates for QE) impact NGDP in a depression?"

I don't normally take a particular Popperian attitude towards science, but the whole problem here can be summed up as the problem of market monetarism (at least as presented by Scott Sumner) can't really be falsified.

An excellent criticism, I think.

UPDATE 20 Jan 2013

Just yesterday I came across this conclusion in a post by Scott Sumner:

Woodford and Bernanke are right; the stance of monetary policy depends on outcomes like NGDP growth and inflation, not interest rates and the money supply.

It's precisely the thing Daniel Kuehn criticized as not falsifiable in Sumner's work:
Sumner's critique meshes together policy goals with actual policies so that evaluations of whether a policy (say, "looser money") is simply being pursued is treated synonymously with whether a goal we all like (say, "NGDP back to target levels") has been achieved.

UPDATE 4 Jan 2016

I just came across this from Jason Smith at Information Transfer Economics:
"Tight money leads to lower expected future NGDP growth. I don’t think that can be disputed."

No, Scott, it really can't be disputed ... because you define "tight" money by lower future expected NGDP growth.

UPDATE 9 Jan 2016

See also "The best guarantee of full employment and price stability" is... full employment and price stability

Monday, September 17, 2012

Illusion, Reality, and the Growth of Debt

Via Random Eyes, FRED graph #4JM:

Graph #1: FRED Graph #4JM
Click graph for the FRED Source Page
The green line is flat in this picture, and the red is nearly flat. It's the blue line that shows an interesting change. It too is essentially flat, at twice the level of Personal Income, but only until 1980. Then it climbs to over four times Personal Income.

The blue line on 4JM shows a ratio of nominal values. It shows that, at any point before 1980 or so, the burden of debt was essentially not increasing.

But it does not show that debt was not increasing. It shows only that debt was not increasing relative to personal income in a time known as the Great Inflation.

It also shows that after 1980, the burden of debt was increasing. The graph shows a change that people often attribute to the policies of President Reagan, or to policy since Reagan. But I think this is not accurate.

Reagan changed many things, but he did not significantly increase the growth of total debt. Surprisingly, a drop in the rate of debt growth started under Reagan, a drop nearly as big as the one that followed the financial crisis of 2008:

Graph #2: Percent Change from Year Ago, Total Credit Market Debt Owed

There was a massive slowdown in the growth rate of TCMDO debt from the mid-1980s to the early 1990s -- a slowdown that eventually opened a door to the increasing debt growth that supported the "miracle" economy of the latter 1990s, the balancing of the Federal budget, and all that came after.

The first graph shows a change that did not happen, and fails to show a change that did happen.

Costs and prices and, presumably, incomes increase with inflation. When prices go up, probably the amount of new borrowing goes up as well. If you're buying a car and it costs more than before, you borrow more to pay for it.

New borrowing increases with inflation. But old debt does not. When incomes go up and new borrowing goes up apace, old debt does not change. The net effect is to make it look as if debt is not increasing. This is true, even though new borrowing continues to increase. That is what Graph #1 shows.

We can take inflation out of the numbers and get a different picture of the TCMDO/PI ratio. The following graph uses "incremental" inflation adjustment of debt (which is a "stock"), and "aggregate" inflation adjustment of Personal Income (which is a "flow"):

Graph #3: Inflation-Adjusted (blue) and Nominal (red) Ratios
The red line here on Graph #3 is the same as the blue line on Graph #1. The blue line here shows the ratio of values with inflation stripped away. We see once again that the remarkable (and often observed) "stability" of debt in the years before 1980 is nothing but an illusion created by a great inflation.