Sunday, March 31, 2013

Debt and Potential GDP

For Mom.

You will remember my recent four-part critique of Potential GDP:

1. Imagine That!, where I called PGDP an "imaginary" number.
2. The Myth of Jobless Recoveries, where I experimented with calculations.
3. The Myth of Robust Analysis, where I expressed some of my doubts, and
4. CBO’s Method for Estimating Potential Output, where I summarized the calculation of Potential Output.

Laurence Ball, one of the authors of the paper I challenged in part three of the series, shot me down by email. (I added part of his reply as an update to that post.)

Here's the thing. I don't know enough about all this stuff to question what he says, so I'm forced to accept that he's right and I'm wrong. I still think the "similarity" of the two lines on his graph is too good to be true. And I still think the similarity must arise from "circular" arithmetic, though Ball clearly understood my objection, and rejected it. But I can't develop these criticisms until I learn more.

The use of Potential Output in comparison to data other than unemployment is much less objectionable, because it avoids the apparent circularity. And if you allow me to think of Potential Output as the "best case scenario" for things that could have been, I think it becomes a useful tool. That's how I'm using it today.

Graph #1: NonFederal Debt as a Multiple of Federal (blue) and the Rate of Change of PGDP (red)

In the early years when the blue line is low, the red line is high. In the late years when the blue line is high, the red line is low.

In the early years when Non-Federal debt is low relative to Federal debt, Potential Output is high. In the late years when Non-Federal debt is high relative to Federal, Potential Output is low. You now know everything you need to know, to fix the global economy.

To get output up, you want Non-Federal debt low, relative to Federal debt.

If you want to know more about Non-Federal debt relative to Federal debt, refer to the posts in this series:

1. Debt Relatives, which shows preliminary comparisons;
2. Debt Relatives: Uncle Sam, where I look at the Federal debt relative;
3. Debt Relatives: The Cousins, a look at the Non-Federal debt relative.
4. Debt Relatives: The Rise and Fall of the Non-Federal Relative, a longer post where I examine the trends in more detail and present some thoughts on policy.

Two additional posts on the topic follow in sequence.

Saturday, March 30, 2013

Change in Debt

Graph #1: Change in Debt from Year Ago, as a Percent of GDP:
BLUE = The Total Debt (TCMDO)
GREEN = The Federal Component of TCMDO
RED = The Non-Federal Component of TCMDO

And they say it's the Federal debt -- the green one -- that's too high. I don't see it.

That last gray bar on the right... About two pixels to the left of that bar, that's when the shit hit the fan. Everything after that point -- everything to the right of that point -- is a consequence of the crisis.

Everything to the left of that point is a cause of the crisis.

(Click graph for FRED source page.)

Friday, March 29, 2013


From The Lessons of History by Will and Ariel Durant:

By the time of Plato's death (347 B.C.) his hostile analysis of Athenian democracy was approaching apparent confirmation by history. Athens recovered wealth, but this was now commercial rather than landed wealth; industrialists, merchants, and bankers were at the top of the reshuffled heap. The change produced a feverish struggle for money, a pleonexia, as the Greeks called it--an appetite for more and more....

Thursday, March 28, 2013


From The Outline of History by H.G. Wells, Chapter XXVI -- "From Tiberius Gracchus to the God Emperor in Rome":

Another respect in which the Roman system was a crude anticipation of our own, and different from any preceding political system we have considered, was that it was a cash- and credit-using system. Money had been in the world as yet for only a few centuries. But its use had been growing; it was providing a fluid medium for trade and enterprise, and changing economic conditions profoundly. In republican Rome, the financier and the "money" interest began to play a part recognizably similar to their roles today.


After the fall of Carthage the Roman imagination went wild with the hitherto unknown possibilities of finance...

In this curiously interesting century of Roman history we find man after man asking, "What has happened to Rome?" Various answers are made--a decline in religion, a decline from the virtues of the Roman forefathers, Greek "intellectual poison," and the like. We, who can look at the problem with a large perspective, can see that what had happened to Rome was "money"

// Related post: When in Rome...

Wednesday, March 27, 2013



When I read opinion pieces by insiders, I often find the ostensible argument less interesting than what is taken for granted. It’s the throwaway lines, the statements that obviously are meant to refer to what “everyone knows”, that can be truly revealing about the state of conventional wisdom.

Absolutely. It's the assumptions. That's where the trouble lies.

Again K-man, on the presentation of such thoughts: thoroughly accepted that it is mentioned only in passing.

Look for the throwaway lines, and challenge them.


" is not what the man of science believes that distinguishes him, but how and why he believes it. His beliefs are tentative, not dogmatic; they are based on evidence, not on authority or intuition."
From A History of Western Philosophy by Bertrand Russell. Simon and Schuster, New York, 1945. p.527.

Tuesday, March 26, 2013

"...the pompous futility of such a Congress..."

From Franklin D. Roosevelt and the New Deal by William E. Leuchtenburg, Chapter 2:
It was frequently remarked in later years that Roosevelt saved the country from revolution. Yet the mood of the country during the winter of 1932-33 was not revolutionary. There was less an active demand for change than a disillusionment with parliamentary politics, so often the prelude to totalitarianism in Europe.

Many Americans came to despair of the whole political process, a contempt for Congress, for parties, for democratic institutions, which was caught by the relentless cynicism of Of Thee I Sing. "There is no doubt in the world," wrote William Dodd, "that both political parties have been bankrupted." The "lame duck" session from December, 1932, through February, 1933, further damaged the prestige of Congress. At a time of mounting crisis, Congress failed to produce a single important piece of economic legislation.

Many argued that the country could get out of the morass of indecision only by finding a leader and vesting in him dictatorial powers. Some favored an economic supercouncil which would ignore Congress and issue edicts; Henry Hazlitt proposed abandoning Congress for a directorate of twelve men. Others wished to confer on the new president the same arbitrary war powers Woodrow Wilson had been granted. Even businessmen favored granting Roosevelt dictatorial powers when he took office. Distressed by the chaotic competition in industries such as oil and textiles, alarmed by the outbursts of violence, convinced of the need for drastic budget slashing, they despaired of any leadership from Congress. "Of course we all realize that dictatorships and even semi-dictatorships in peace time are quite contrary to the spirit of American institutions and all that," remarked Barron's. "And yet -- well, a genial and lighthearted dictator might be a relief from the pompous futility of such a Congress as we have recently had... So we return repeatedly to the thought that a mild species of dictatorship will help us over the roughest spots in the road ahead."

(In case you were wondering why Hayek was all worked up over totalitarianism.)

Matters of secondary importance

From The Road to Serfdom:
Most planners who have seriously considered the practical aspects of their task have little doubt that a directed economy must be run on more or less dictatorial lines... The consolation our planners offer us is that this authoritarian direction will apply "only" to economic matters... Such assurances are usually accompanied by the suggestion that, by giving up freedom in what are, or ought to be, the less important aspects of our lives, we shall obtain greater freedom in the pursuit of higher values...

Unfortunately, the assurance people derive from this belief that the power which is exercised over economic life is a power over matters of secondary importance only, and which makes them take lightly the threat to the freedom of our economic pursuits, is altogether unwarranted. It is largely a consequence of the erroneous belief that there are purely economic ends separate from the other ends of life... If all rewards, instead of being offered in money, were offered in the form of public distinctions or privileges, positions of power over other men, or better housing or better food, opportunities for travel or education, this would merely mean that the recipient would no longer be allowed to choose and that whoever fixed the reward determined not only its size but also the particular form in which it should be enjoyed.

So long as we can freely dispose over our income and all our possessions, economic loss will always deprive us only of what we regard as the least important of the desires we were able to satisfy. A "merely" economic loss is thus one whose effect we can still make fall on our less important needs, while when we say that the value of something we have lost is much greater than its economic value, or that it cannot even be estimated in economic terms, this means that we must bear the loss where it falls. And similarly with an economic gain. Economic changes, in other words, usually affect only the fringe, the "margin," of our needs... This makes many people believe that anything which, like economic planning, affects only our economic interests cannot seriously interfere with the more basic values of life.

This, however, is an erroneous conclusion.

Economic planning would not affect merely those of our marginal needs that we have in mind when we speak contemptuously about the merely economic. It would, in effect, mean that we as individuals should no longer be allowed to decide what we regard as marginal.
Excerpts from The Road to Serfdom by F.A. Hayek, Chapter 7.

Hayek was writing about central planning, in a chapter titled "Economic Control and Totalitarianism". But his objection to central planning is the application of his analysis. Don't be distracted by it. Look instead at the essence of Hayek's argument: Economic issues are far more significant than they seem.

Monday, March 25, 2013

Like drowning in water that's a little less deep

From the News of Iceland
Mr. Sigmundur David Gunnlaugsson, chairman of the Progressive Party, wants to reach an agreement with the foreign creditors of the fallen banks in Iceland where they hand over part of the profit from their claims on the banks, and that money would be used to write down household mortgages.

Sigmundur says that if the creditors don't play along, the government should tax them and get the money that way...

Sounds promising. I mean, if private debt is the problem, then reducing private debt is the solution. But then I read a little more of the article:
Many mortgages in Iceland are price indexed, that is indexed to the inflation. The principal of these loans increased substantially after the financial crisis, because of the high inflation that Iceland experienced. Sigmundur David wants to correct this, and write down price indexed mortgages that were taken before the crisis by around 20%...

So it looks to me like the Sigmundur guy is trying to reduce inflated mortgage balances down to what they were before the crisis.

Before the crisis, those debts were a problem in search of a crisis. Sigmundur's solution is not enough.

Source: Trading Economics

There's a good chance the 20% writedown would not even be enough to reduce mortgage principal to pre-crisis levels.

Debt and Inequality

Lucky Tan shows this graph at Diary of a Singaporean Mind:

Graph #1, Source: Video on the Income Gap...

Gets bigger if you click on it.

Most unequal, down at the bottom of the stack, is Singapore. Next above that, USA.

Least unequal, at the top of the chart: Japan.

Japan, which has had a "lost decade" for more than twenty years, and GDP still refuses to grow:

Graph #2: Real GDP in Japan (Log Scale)

Japan, where quantitative easing has made it that there is a whole dollar of circulating money for every dollar's worth of output produced, and debt still refuses to fall:

Graph #3, Source: Japan versus USA (2)

Mostly private debt, by the way.

Least unequal. Maybe inequality is not the driving force. Maybe debt accumulation is the driving force, and inequality is a result.

Sunday, March 24, 2013

Policy works.

At heteconomist, a good title from PeterC: Why Neoliberals Pretend Private Debt Doesn't Matter and Public "Debt" Does, and a very good opening line:

The neoliberal policy approach in the decades leading up to the crisis basically amounted to enticing or pushing people into increasing levels of private debt.

I still don't know what a "neoliberal" is, nor care to know. But as PeterC says, economic policy for decades pushed and enticed and cajoled and encouraged more and ever more debt.

You don't find people saying things like that very often. But it is so important to realize that most of what happens in the economy happens because of policy.

Economists, of all people, go around saying things like fiscal policy doesn't work and monetary policy works only in the short term, if at all. So why, I ask, are those people still in that line of work?

My view is that policy works. Monetary policy takes money out of circulation to fight inflation. Fiscal policy encourages spending to make the economy grow. Together, the policies encourage more spending but fail to provide the money. So people use credit.

Policy works: Monetary and fiscal policy caused the expansion of credit-use and the accumulation of debt.

Was this the intent of policy? No, I think not. But economists seem never to look at the combined effect of the two policy tools. So, for decades, policy "basically amounted to enticing or pushing people into increasing levels of private debt."

Saturday, March 23, 2013

The Right of Coinage

From The End of the Ancient World and the Beginnings of the Middle Ages, by Ferdinand Lot (first published in 1927 in French). Chapter 12 section 3.
In the seventh century, the right of coinage, the royal prerogative par excellence, passed over to the episcopal or monastic churches or to private persons; the treasury perhaps still collected part of the profits of coining. Mints multiplied in the cities, "chateau" (castra), vici, and even mere villas. The history of the coinage shows in a striking fashion the disintegration of the royal power.

After the end of the seventh century, the issue of gold coins slowed down and then completely disappeared, to re-appear in France only under the reign of St. Louis, an undeniable sign that relations with the gold-producing countries had ceased and also that Gaul, if it still perhaps bought something from the East, no longer sold it anything. In the eighth century even silver money tended to pass out of currency, at least in the Rhine districts, payments being made in grain, cattle, horses, etc., rather than in metal specie.

These are unequivocal signs of the retrograde trend of the economic system to more primitive forms.

Looks to me like St. Louis is Louis IX of France (April 25, 1214 – August 25, 1270).

Friday, March 22, 2013

H.G. Wells and the Gold Standard

In The Outline of History, H. G. Wells described conditions in Europe following World War I. For Wells, the postwar disorder was perpetuated by the "delusion of national sovereignty." The disorder was "enormously complicated by the international tangle." For example, there was no unified system of money and credit.

According to Wells, a "frank repudiation" of Europe's war debts (debts largely owed to the U.S.A.) would have "cleared the air." But "only a powerful federal government in Europe could have been so bold and frank," and Europe lacked such a government. Therefore, Europe remained burdened with its war debts until those debts led to impoverishment of peoples and collapse of governments.

Wells summarizes the monetary troubles of several European states, calling his work "history in an arithmetical form." He leaves it to the reader to imagine the anxieties, hardships, and even deaths caused by the "barometric antics of the European currencies."

Summarizing the effects of the European monetary troubles after World War I, Wells writes: "The return to the gold standard in a time when the production of commodities in general outran the release of gold for coinage was all to the advantage of the creditor. Prices fell. He reaped more than he had sown and enterprise was crippled."

Source: The Outline of History by H.G. Wells, chapter 39.

Thursday, March 21, 2013

"The distortions resulting from higher tax rates would then constrain the economy’s trend growth for a long time."

How about the distortions resulting from high and higher levels of debt other than the Federal debt? These distortions These costs have already constrained the economy’s trend growth for a long time. Since the 1960s.

Opening with conclusions,

Opening with conclusions, in Fiscal Consolidation Strategy: An Update for the Budget Reform Proposal of March 2013, John F. Cogan, John B. Taylor, Volker Wieland, and Maik Wolters write:
As a consequence of the global financial crisis and great recession government deficits have risen substantially, thus creating the need for a fiscal consolidation strategy to reduce deficits and stabilize government debt. Looking forward, sustained spending increases are particularly worrisome, because they ultimately require raising tax rates beyond pre-crisis levels, even after the economic recovery. The distortions resulting from higher tax rates would then constrain the economy’s trend growth for a long time.

One could argue that Figure 1 consists largely of prediction, and that less the prediction, the Figure is largely empty:

Graph #2: Similar to Figure 1 but without Prediction

One could argue that the starting point for Figure 1 was "cherry picked" to give the greatest effect:

Graph #3: Similar to Figure 1 but with a Different Cherry Picked Start Date

One could look at all the years in the St. Louis Fed's FRED dataset, with an elliptical trend line painted on:

Graph #4: Maybe This Is What the Trend Looks Like
On Graph #4 you can see the big off-trend spike concurrent with the Second World War. A bit after that, you can see a small off-trend spike, peaking at 20, concurrent with the Korean War. And you can see a general pattern that follows the red trend line.

One could argue that the budget balancing of the 1990s and the feeble spending of the 2000s left the Federal component low for near two decades, and that this insufficiency was the cause of the global financial crisis and great recession. I'm not prepared to make that argument, but one could argue.

Alternatively, one could argue that Federal spending reached a plateau in the 1950s and might have rested at that level indefinitely. But the ratio was undermined when GDP growth faltered:

Graph #5: Maybe This Is What the Trend Looks Like

Minsky's 1966, again.

Count 'em

Yesterday I wrote the past, when the economy WAS better, we could not and did not draw down the Federal debt.

I don't like saying things like that without checking my facts. So I checked some facts, finished up that post, and decided to use my fact-checking for my next post. Waste not, want not.

The FRED "Federal Surplus or Deficit" data:

Graph #1: Federal Deficits (and Surpluses) since 1901
Easy to see the deficits got big and bigger since the 1970s. Can't see much of anything before that, except World War Two.

How to look at the numbers and see whether budgets were generally balanced or generally unbalanced? Don't need to know if deficits are big or bigger. Just need to know if they are deficits or surpluses. I decided to count years.

The first year, 1901, had a surplus. Count that as one. The next year, surplus. Two. The third year, surplus. Three. The fourth year, deficit. Two. So far, I count two more years of surplus than deficit.

So I did the whole 112 years like that. If I end up at the end with a total of 112, then all the years had surpluses. If I end up with -112, then all the years had deficits. If I end up with zero, then half the years had surpluses and half had deficits. If I end up with -46, then 46 more years had deficits than surpluses.

Instead of just getting the final tally, I made a graph:

Graph #2: Since 1901, count of Surplus Years less Count of Deficit Years

Between 1901 and 1917 the count varied between 1 and 4. It was always "advantage surplus" in those years. From a tally of 4 in 1916, three deficits in a row during World War One pushed the tally down to 1 in 1919. So, from 1901 to the end of WWI, there was one year more of surplus than of deficit. Remarkable.

After 1919 it was surplus after surplus through the roaring '20s, to a max tally of 12 in 1930. Thereafter, the Great Depression and then World War Two saw only deficits. The tally bottomed out at -4 in 1946.

Interestingly, a string of budget surpluses led into the Great Depression, and a string of budget deficits led out of the Great Depression.

Between 1946 and 1960 it was all back-and-forth, reminiscent of the first two decades of the century, except it was "advantage deficit". In 1960, as in 1946, the tally was -4.

From 1960 to 1997 it was one deficit after another in a continuous run, with the single exception of 1969's balanced budget. The low point in 1997 was -39.

Then there were a few years of surplus. The tally increased by four, to -35 in 2001. You will remember the balanced budgets of the Clinton years, I expect.

Finally, from 2001 to 2012, an uninterrupted string of deficits. The final tally as of 2012 was -46: 46 of the 112 budgets were in deficit, plus exactly half of the other 66.

In total, 33 budget surpluses in 112 years, and 79 deficits.

If we start instead from 1960, 6 of the 53 years show surplus. 47 show deficit.

For graph #2 and the data, see my Google Drive spreadsheet.

Wednesday, March 20, 2013

Distraction by the Pound Klein

Every time I read the name Ezra Klein I remember Bob Dylan singing of Ezra Pound and T.S. Eliot.

At Mike Norman's, Tom Hickey offers Ezra Klein — Our deficits aren’t as bad as Washington thinks. Titles like that always interest me, but it's a kind of dual fascination. Because the deficits are bad. Or maybe I just watch too much TV.

An excerpt from Tom's excerpt:

Future deficits are a legitimate concern. But as either Yogi Berra or Niels Bohr said, predictions are very difficult, especially about the future. And future deficits are, annoyingly, situated entirely in the future.

I'm torn on this, too. Mini haha is not good argument. But prediction is troublesome, particularly when it contradicts evidence.

That bit of Klein reduces to this: Future deficits are a legitimate concern. But we don't know about the future. And that is true.

However, we do know something of the past.

And that brings me to Paul Krugman, who likes to say that we need bigger deficits now, and we can -- and we should [Krugman adds] -- deal with the Federal deficit later, when the economy is better. But for now [he says] we need bigger deficits.

That's frustrating as hell for me, because in the past, when the economy WAS better, we could not and did not draw down the Federal debt.

Oh, don't tell me about the Clinton years. I know all about the Clinton years, when the budget briefly came into balance. The budget came into balance because of a late '90s "macroeconomic miracle" of economic performance which, though they know it not, was due to the slow growth of private debt since 1986 and the fast growth of circulating money in the early 1990s. I know all about the Clinton years.

That balancing act didn't last, because they didn't know what made it happen in the first place. They couldn't duplicate the results. They tell us they can get growth by cutting the Federal debt and deficit. The fools have it backwards.

You have to reduce private debt first, to get the economy growing. Then the growth makes the Federal deficit fall. That's how it works. That's what gave us the miracle of the late 1990s. Heck, that's what gave us the "golden age" after World War Two. It will work again, if we ever get around to trying it.

In the meanwhile we have Krugman pretending we can balance the budget later. That's why he has no friends on the right. They know what I know about the past. I think Paul Krugman knows, too. I think he's bullshitting. He has an audience: People who do not oppose Federal spending like what he says, and want to buy his bullshit.

Ezra Klein bought it, apparently.

Klein's opening is funny:

This week marks the beginning of the U.S. budget season.... In honor of the season, Americans everywhere will wear traditional budget-season hats and eat the customary budget-season meals, which include, of course, a rich dessert that we assume will be offset by future weight loss.

The next chunk of Klein's article is just stupid. Summarizing "the left-leaning" Michael Linden, who begins with the prediction that "debt in 2037 will be at a truly scary 199 percent of gross domestic product", Klein watches as Linden talks the number down, from 199% to 169%, to 153%, to 112%, to 97%, and finally "to about 71 percent of GDP by 2037" Klein writes, quoting Linden.

Ezra Klein considers Linden's work "a welcome antidote to the deficit hysteria that permeates Washington." But Klein seems to miss the fact that prediction is prediction. It doesn't matter whether you're predicting numbers up or predicting numbers down, prediction is still prediction. I suppose if inflation-going-up is inflation and inflation-going-down is "disinflation", then prediction-going-down could be "disprediction". But it's still prediction, just the same.

After recapping all of that from Linden, Klein says he doesn't buy it. So, why did he present each piece of it in turn? Seven paragraphs Klein used. Plus a graph. To recap something he says he doesn't buy.

Smoke and mirrors, that's why he presents it.

Klein notes that CBO offers two projections. He rejects the high-debt scenario in favor of the "simple, mechanical projection of future deficits based on current law." Basically, he's saying Linden's work is irrelevant. (So again: Why present it?)

It's all a diversion. In his opening remarks, Klein says

Today’s deficits are, if anything, too small.

Like Krugman, Klein wants bigger deficits, for now. But he also says

Future deficits are a legitimate concern.

Like Krugman, he wants to deal with the deficits later.

The smoke and mirrors only serves to distract you from the real issue, which is that when later gets here, we won't be able to balance the budget then, either.

Don't be distracted. You can't balance the budget by cutting the spending. It doesn't work that way. You can only balance the budget by getting the economy to grow. And you can only get the economy to grow by reducing private debt. Take your hundred measures of oil, sit down quickly, and write fifty.

Tuesday, March 19, 2013

Compensation per Hour

Random Eyes brought me to this graph:

Graph #1: Percent Change from Year Ago, since 1960

Note that the years of consistently high percentage increase are the years of the Great Inflation, from the mid-1960s to the early 1980s.

Here's the same graph, for all the years available at FRED:

Graph #2: Percent Change from Year Ago, since 1947

And here's how it looks when you subtract out the inflation rate:

Graph #3: ΔCompensation less ΔCPI
Choppy, because it subtracts one rate-of-change from another. However, the thing looks to me like it's all downhill, except for the late 1990s, the miracle years.

Maybe you could argue that the trend was flat till the latter 1960s.

Another look. This time, the ratio of given values. No "percent change".

Graph #4: Compensation per Hour, Relative to the Price Level
Compensation increased consistently faster than consumer prices from 1947 to around 1973. Then compensation stalled, increasing almost not at all until after 1997. Then it went up again. Interesting I think, because of the three distinct phases.

Monday, March 18, 2013

Okay, maybe half the pageviews are mine

"Charts: Is the big US budget problem entitlement spending or ..."

You know how it goes. One thing on the internet leads to another.

I'm looking for something that grabs my attention. Google turns up a title that grabs. I borrow the title and click the link.

James Pethokoukis at AEI, Charts: Is the big US budget problem entitlement spending or defense spending?. This chart was good:

After the charts there are a few comments. Here's the first part of the first one. The comment is from Jon Murphy:

Let’s talk about what’s going on here.

Fact: the US government has a spending problem.

Fact: The US government has a budget deficit of approximately $1T.

Fact: CBO, OMB, and the Obama Administration all have projections that the debt will only get worse.

Fact: Something has to be done about spending.

So, let’s talk about spending.

What's wrong with Jon Murphy's analysis? Everything. For starters, he starts with a conclusion: "the US government has a spending problem." How does he know that? I don't know that.

The balance of Jon's post identifies components of the problem spending: entitlements, interest, corporate welfare, military spending.

His conclusion: "The US has a spending problem. This much is crystal clear."

You can't start with conclusions, and make good sense of things.

You can't start with an economy that has gone to shit, and understand how it got there.

You have to start with no assumptions about where the problem lies, and you have to look at the economy beginning in a time when the economy was good. And you have to watch things change for half a century or more. And that'll give you a feel for where the problem lies.

You don't start (and end) with "the US government has a spending problem."

Jon is right about one thing: He writes, "Interest will also be a problem going forward, but that can be curbed by dealing with the debt." Yes, but Jon is probably thinking of the Federal debt, which is the small part of the debt problem. And interest? Interest is the small part of the cost of debt.

And the cost of debt? That *IS* the debt problem.

Sunday, March 17, 2013

Who wants to tax the rich?

Before he found God, he was one of Nixon's henchmen: Charles Colson. In Chapter 9 of his 1989 book Against the Night: Living in the New Dark Ages, Colson wrote:
Near the end, Rome's agriculture and trade languished while inflation flourished. Yet the great city on the seven hills had survived such troubles in the past. The major problem was that the empire had not been well-governed for years -- not since the strong and principled leadership of Marcus Aurelius. Skill in government had long been a Roman specialty; but the cruel expedients by which later emperors tried to force revenue out of people who could not pay, while allowing those who could pay to escape, were not good government.

A confusion of sounds

At the Center for Individual Freedom, CBO Report Shows Excessive Spending, Not Insufficient Taxation, Explains Our Deficits by Timothy H. Lee:

In 2007, the federal government took in an all-time record $2.6 trillion in revenues.

That year’s deficit was merely $161 billion – quaint in retrospect.

This year, according to a report from the Congressional Budget Office (CBO), incoming federal revenues will break that 2007 record and reach a new all-time high of $2.7 trillion.

Yet this year’s deficit will be nearly $1 trillion.

So if revenues for 2007 and 2013 are the same, yet the 2013 deficit is nearly one trillion dollars, we can isolate the obvious culprit: excessive spending.

The "obvious" culprit.

For Tim Lee, then, deficit spending is by definition excessive spending.

An on-line definition of "excessive" is More than is necessary, normal, or desirable. So according to Mr. Lee, any and all spending in excess of revenue is unnecessary, abnormal, and undesirable. Lee's definition is a preemptive dismissal.

Mr. Lee, and millions of others, confuse the word "excessive" with the word "excess". If there is a Federal deficit, then Federal spending is in excess of Federal revenues. But "in excess of" is not the same as "excessive", despite the similarity of sound.

Saturday, March 16, 2013

Things get worse

Marcus Nunes shows this one

Graph #1: NGDP, 1992-2012, Source: Marcus Nunes, Historinhas

with a dividing line there, indicating the start of Bernanke's Chairmanship of the Fed. He wants you to see the big dip after Bernanke took over. Marcus likes to think that everything was fine until Bernanke took the chair in 2006. I disagree.

I see two dips on Marcus's graph; I see progressive decline.

Marcus always says the Great Moderation is unrelated to the Great Recession. He thinks the years before 2006 and the years since 2006 are unrelated. I think what happened after 2006 was largely a consequence of what happened before.

Marcus's graph goes back only to 1992. Extend it back a few years more,

Graph #2: NGDP, 1985-2012
and you can see another decent size dip during the 1991 recession -- as deep as the 2001 dip, yes, but only half as wide. Only half as long, timewise, the 1991 dip. Only half as much volume of lost output, give or take. The 2008 dip is twice as deep as the 2001 dip. The 2001 dip is twice as wide as the 1991 dip. And -- well look at that! -- the 1991 dip is twice as deep as the 1986 dip. Things get worse.

Off the graph to the left, the blue line was higher and the dips showing less moderation. But you know, the graph shows actual GDP -- actual-price, inflating-price GDP. So lots of the downtrend since the 1970s can rightly be attributed to the beating down of inflation. Maybe we should be looking at inflation-adjusted GDP instead.

Since 1980:

Graph #3: RGDP, 1980-2012
Consistently higher before 2000 than after. Things get worse.

And again, inflation-adjusted GDP -- this time since 1947:

Graph #4: RGDP, 1947-2012

A lot less "moderation" in the left half than in the right. But it looks to me like mostly downtrend, through the whole graph. I don't just see trouble only after 2006.

Here's another view of it -- this time not inflation-adjusted GDP, but inflation-adjusted potential GDP. Best-case, perfect-world GDP:

Graph #5: PGDP, 1949-2012

I don't just see trouble after 2006. I see long-term decline.

Oh -- and if Graph #5 shows hypothetical decline, #6 shows a real-world decline in our use of the productive capacity at our disposal:

Graph #6: Capacity Utilization, 1967-2013
Capacity Utilization shows a long-running downtrend. Things get worse.

But you know what? All the above graphs look at "percent change from year ago" values. They all show that annual growth rates are in a long-running downtrend. Let's stop and look at things a different way.

Graph #7 below shows inflation-adjusted GDP (blue) and Potential GDP (red) in billions of dollars. The lines go up, meaning GDP is always getting bigger as the years go by. Always, except after 2006 there where the blue line drops. That's the part that bothers Marcus. Bothers a lot of people, really, and for good reason.

Still, the general trend of both lines on this graph is up, not down. That's true. But what the other graphs tell me is that these lines have been going up slow and slower as time goes by. That's my point, really. After 2006, the blue line drops? Yeah, it's a problem. But I think we could have seen it coming for a long time. Because the lines have been going up slow and slower for a long time.

A lot of people might say they knew it was coming. That wouldn't surprise me at all.

What the earlier graphs show is that the lines are going up slow and slower. Doesn't look like it on Graph #7, does it? Looks like the red and blue lines are gradually curving upward. But that's a feature of growth. A mathematical property of growth. If something grows by doubling every year, it goes from 1 to 2 to 4 to 8 to 16 to 32 and before you know it, the numbers are too big to do in your head. That's a constant rate of growth, that doubling every year. But even though the rate is constant, if you plotted the numbers, you would draw a line that curves up. And it wouldn't be a gradual curve, either.

Even if the growth is much slower that "doubling every year", if the growth rate is constant, then the line curves up when plotted.

And even if the growth is slowing, rather than constant, there is a good chance the line will curve up when you plot the thing. But just because the line curves mostly up, it doesn't mean everything is rosy. Like I said, a lot of people would say they knew trouble was brewing.

If you want to look at a constant growth rate on a graph, and you don't want to be deceived by the up-curving properties of growth, then you can use a log scale on the vertical axis. When you use a log scale, a constant growth rate looks like a straight line when you plot it, not a line that is curving up.

So if you plot the thing on a log scale and the line is straight, then the growth rate is constant. If the line curves up even though it's on a log scale, then the growth rate is fast and faster. If the line curves down, the growth rate is slow and slower.

Inflation-adjusted GDP and potential GDP, in billions:

Graph #7: HOVER Graph showing RGDP and PGDP

Move the mouse away from Graph #7 to see the normal plot. Hover the mouse over Graph #7 to see the log scale plot. The normal plot shows growing GDP. The log plot shows that growth has been slowing for the last 60 years. With the mouse over the graph, the graph shows less and less up-slope as time goes by. Slow and slower growth. The problem goes back to a time long before 2006.

Park your mouse on Graph #7.

The graph shows nothing but a slowing of growth. Things get worse.

Friday, March 15, 2013

CBO’s Method for Estimating Potential Output

From A Summary of Alternative Methods for Estimating Potential GDP (PDF):
CBO’s Method for Estimating Potential Output

CBO’s estimate of potential output is based on the framework of a textbook model of long-term economic growth, the Solow growth model... CBO estimates trends —that is, removes the cyclical changes—in the labor and productivity components by using a variant of a relationship known as Okun’s law.

Okun’s law postulates an inverse relationship between the size of the output gap (the percentage difference between GDP and potential GDP) and the size of the unemployment gap (the difference between the unemployment rate and the natural rate of unemployment). According to that relationship, actual output exceeds its potential level when the rate of unemployment is below the “natural” rate of unemployment; actual GDP falls short of potential when the unemployment rate is above its natural rate.

For the natural rate of unemployment, CBO uses its estimate of the nonaccelerating inflation rate of unemployment (NAIRU). That rate corresponds to a particular notion of full employment—the rate of unemployment that is consistent with a stable rate of inflation. The historical estimate of the NAIRU derives from an estimated relationship known as a Phillips curve...

CBO estimates an Okun’s Law relationship for hours worked and total factor productivity (TFP). It uses regression equations that link each variable to the same set of explanatory variables (including the unemployment gap) to capture the effects of fluctuations in the business cycle. It also uses several time trends, which constrain the growth of the potential variables to a constant rate over one or more specified historical periods. CBO then calculates the potential levels of hours worked and TFP from the predictions of the equations when the unemployment gap is set at zero. Those potential levels are combined with the capital input to compute potential GDP.

1. Start with the Phillips curve.
2. Observe the current relation between inflation and unemployment.
3. Use this relation to estimate the NAIRU.
4. Use the NAIRU as "the natural rate of unemployment".
5. Compare the natural and actual rates of unemployment.
6. Call the difference "the unemployment gap".
7. By Okun's law, the output gap is twice the size of the unemployment gap.
8. Calculate the output gap.
9. Add the output gap to actual output, to get potential output.

There's more to it. But this is where the Potential Output number comes from.

Thursday, March 14, 2013

The Myth of Robust Analysis

// UPDATE 12 april 2013: See my follow-up post, which invalidates this one.

If you mix red pigment into white paint, the paint gets red.

Yesterday we looked at Chart 2 from The Myth of 'Jobless Recoveries'. Today we consider Chart 1. Laurence Ball, Daniel Leigh and Prakash Loungani write:

Chart 1 illustrates the fit of the estimated Okun’s Law by plotting the unemployment gap (the gap between unemployment and the natural rate) against the output gap (output relative to potential). The relationship is very tight. No year is a major outlier in the graphs.

Graph #2: Ball, Leigh and Loungani's Chart 1.
Okun’s Law, 1948-2011 (Annual US data)

Yesterday, to figure out Chart 2, I reorganized a formula to make it compatible with Okun's law. Chart 2, as I understand it, compares actual unemployment to some calculation of the output gap and the natural rate of unemployment, and finds an amazingly close match for 65 years.

After re-arranging terms, Chart 2 compares the unemployment gap to the output gap. Today's focus, Chart 1, compares the unemployment gap to the output gap directly, one gap per axis. Both charts from the Econbrowser post consider the Okun's Law relation. Well, sure: The topic of that post is the validity of Okun's law.

The Econbrowser post includes both charts under the heading "U.S. evidence: Fit & Stable". To me this means that Laurence Ball of Johns Hopkins University, and Daniel Leigh and Prakash Loungani of the IMF, consider their graphs evidence of the validity of Okun's law. I do not.

Why not? Look again at what they wrote:

Chart 1 illustrates the fit of the estimated Okun’s Law by plotting the unemployment gap (the gap between unemployment and the natural rate) against the output gap (output relative to potential). The relationship is very tight.

They compare the unemployment gap to the output gap and find astonishing validity. That is to say, there is a tight relation between two gaps: the gap between actual and hypothetical unemployment, and the gap between actual and potential output. A very tight relation.

But here's the thing. To figure potential output, the Congressional Budget Office uses the unemployment gap. They take that gap and stretch it to fit over actual output. That gives them the output gap. The output gap looks like the unemployment gap by design.

Then they use actual output and the output gap to estimate potential output. So when you look at potential output, part of what you're seeing is the unemployment gap.

Just as Milton Friedman worked inflation into his "money relative to output" (by using inflation-adjusted output in the denominator), the CBO works the unemployment number into the calculation of potential output. Just as Milton Friedman's results are skewed to look like inflation, so is the CBO calculation of potential output skewed to look like unemployment.

In the case of the CBO, this is not a problem. CBO is modeling potential output, based on the natural rate of unemployment. There's nothing wrong with that. But for people who want to use potential output in other calculations, it is important to remember how potential output is figured. Otherwise you can end up doing bad arithmetic, just like Friedman did.

Laurence Ball, Daniel Leigh and Prakash Loungani take potential output and work it backwards. They show similarity between the output gap and the employment gap. But you should expect to see this similarity, just as you should expect to see similarity to inflation in Milton Friedman's numbers. But the similarity does not mean what Ball, Leigh and Loungani say it means. They say it is evidence Okun's law is valid.

It is not evidence. The output gap looks similar to the unemployment gap because the output gap has the unemployment gap figured into it: The paint is red because it has red pigment mixed in.

All they have done, really, Ball and Leigh and Loungani, is check the CBO's numbers. CBO starts with unemployment and ends up with potential output. Ball and all start with potential output and end up with unemployment numbers. If Ball's final numbers match the numbers CBO started with, it only means that nobody made a mistake in their arithmetic. It doesn't mean Okun's law is valid.

I suppose if they use Potential Output from some other source, calculated some other way, then my objection may be the thing that's not valid. That could be. But if they identified their data sources in the post, I didn't see it. And since their charts show an unbelievable validity, I cannot trust their charts.

// Update 6:26 AM 17 March 2013

In response to an email, Laurence Ball replies:

In our main results, we calculate potential output and output gaps separately from unemployment gaps and the natural rate, using the Hodrick-Prescott filter in each case. You're right that using CBO output gaps is circular--we mention that in the paper.

Wednesday, March 13, 2013

The Myth of Jobless Recoveries

Okun's law asserts a relation between the rate of unemployment and the rate of economic growth. The higher the unemployment, the lower the growth; and the lower the unemployment, the higher the growth. Makes sense. But Okun's law is stronger than I let on: It associates a one-point change in unemployment with a two-point change in output. That's pretty specific.

A recent guest post at Econbrowser reported the testing of Okun's Law, and found that the two-to-one relation holds good. In The Myth of 'Jobless Recoveries', Laurence Ball, Daniel Leigh and Prakash Loungani write: "Fifty years after Okun’s paper, we find that this relationship fits very well, including during the Great Recession." Okun's Law, they report, is "strong and stable". They offer this graph:

Graph #1: Ball, Leigh and Loungani's Chart 2.
Actual and Fitted Unemployment Rate, US, 1948Q2-2011Q4.

There are two lines on the graph. One of the lines is the actual unemployment rate. The other is an estimate of the unemployment rate which they got by following Okun's law backward from output. The two lines are so close together they look like one line. Ball, Leigh and Loungani offer this as evidence Okun's law is strong and stable.

Ball, Leigh and Loungani say that their chart "shows the tight fit between actual unemployment and the estimate based on Okun’s Law." Statements like that catch my eye. I like to see if I can duplicate the results. Duplication tests both the selection of data and the calculation of values. It helps me understand the calc.

The "actual" unemployment rate is a time series I can find at FRED. That part is straightforward. What I have to work out is "the estimate based on Okun’s Law." Ball, Leigh and Loungani state the law clearly:

The textbook version states when U.S. output dips one percent below its potential, unemployment rises above its natural rate by about half a percentage point.

In other words,

Formula 1.

But they say their graph shows "actual" unemployment (the UNRATE, I presume) and the "fitted unemployment rate from Okun specification". Plus, their graph looks like the UNRATE graph, with the high peak around 11 and the last peak around 10.

To get "actual" by itself, I added the Natural Rate of Unemployment to both sides:

Formula 2.

I plotted that at FRED:

Graph #2:Actual Unemployment (blue) and the "Fitted" Number (red)

Pretty good match. I don't like it though, because to make it match I had to use two vertical axes with different scales. Maybe that's because of the "two-to-one" thing, which I didn't consider in this graph. Couldn't figure out how to get FRED to do that. (The output values are log values. At FRED I took log values as the last step. So there was no extra step where I could multiply or divide by two.)

(Oops. I left the "times 2" out of my formulas, too.)

I thought it might work better if I left NROU with UNRATE, as in the first formula above. Went back to FRED and came up with this:

Graph #3: The Employment Gap (blue) and the Output Gap (red)
Click Graph for FRED Source Page

For the blue line I started with the actual rate of unemployment and subtracted the natural rate of unemployment. (Thus, where actual unemployment is above the natural rate, the blue line is above zero. Where actual is below the natural rate, the blue line is below zero.)

Because both unemployment series are given in percent values where 5% is presented as 5.0 rather than 0.05, I divided the result of subtraction by 100 to get the decimal value.

Finally, I multiplied by 2 because Okun's law says there is a two-to-one relation between unemployment and output.

For the red line I took potential output and divided it by "real" GDP. (Thus, where real output is below potential, the red line is high. Where real output is above potential, the red line is low.) Then I applied FRED's "natural log" transformation.

You see the result. The two lines are a good match to each other, and the graph is similar to the "Chart 2" graph. My numbers are lower, because I'm subtracting the natural rate from the actual rate. But both sets of numbers are lower on this graph, and the two sets still match up well.

Is the similarity "evidence" that Okun's Law holds good? Come back tomorrow...

Tuesday, March 12, 2013

Imagine That!

Both potential output and the natural rate of unemployment are imaginary numbers. Estimates. But not like estimates of actual unemployment and actual output, which are based on actual conditions. As Arthur Okun wrote in 1962:

The quantification of potential output -- and the accompanying measure of the "gap" between actual and potential -- is at best an uncertain estimate...

According to an old FRBSF Economic Letter,

The natural rate is the unemployment rate that would be observed once short-run cyclical factors have played themselves out.

(Emphasis added.)

Of the NAIRU, Bill Mitchell says simply, "it is not observed."

The NAIRU. That's the number CBO uses to calculate the natural rate of unemployment:

For the natural rate of unemployment, CBO uses its estimate of the nonaccelerating inflation rate of unemployment (NAIRU).

We're dealing with hypothetical quantities here. The unobserved NAIRU is used to calculate the natural rate of unemployment. The natural rate of unemployment is used to calculate potential output.

Oh... and potential output? According to William Gavin, potential output is "a theoretical concept that means different things to different people."

Monday, March 11, 2013

An Interesting Comparison

Via Random Eyes: Corporate Profits and Personal Income, pinned at 1960:

FRED Graph#4kX

Sunday, March 10, 2013

Morrisey lines

After looking again at yesterday's graph, it occurred to me to ask: How much of the revision to Potential GDP is in the past, really, and how much is in the future? Despite Altig and Gavin's graphs, and the 1977 ERP, it looks like most of the revision is in the future.

So I copied the graph from yesterday and changed it by deleting all the data from after the date-of-estimate. For each date in the legend, I deleted all the numbers after that date for that series. I stripped away the future. What's left does show a bit of revision, but not a lot.

Graph #1

William Gavin is right: Estimating the past is a lot easier than estimating the future.

Still, the graph reminds me of high school math class. Mrs. Morrisey would draw a diagram on the chalkboard and then, when her lines didn't intersect like she wanted, she would go back-and-forth with the chalk and make a good thick line to show the intersection she was trying to show. My buddy called them Morrisey lines.

// Google Drive Spreadsheet

Saturday, March 9, 2013

Cooperating with Alfred

I finally figured out where to get the "vintage" data that ALFRED offers. After you find the series you want (in my case, Potential GDP) and after you get a graph on the screen, that's when you click download.

ALFRED then gives you a selection window with several old versions of the data -- all the versions they have, I guess. You just highlight the vintages you want (in my case, all of them) and the thing is ready to send you a file (in my case, a zipped Excel file).

I wanted to look at Potential GDP because, as you know, it has been revised down.

Turns out, the "real" PGDP data from ALFRED comes in not only several vintages, but also several different "base year" series. To whit:

Data ValuesStart Year
Billions of 1982 Dollars1991-01-30
Billions of 1987 Dollars1992-01-22
Billions of Chained 1992 Dollars1997-01-28
Billions of Chained 1996 Dollars2000-01-27
Billions of Chained 2000 Dollars2004-09-13
Billions of Chained 2005 Dollars2010-01-26

If you select one year's data from all the different vintages and make a graph of it, the graph shows an upward-stepping pattern. Upward-stepping, because every time they pick a different base year and adjust for inflation, the number gets bigger. So, if I want to compare vintages across base years, I'll have to adjust for base years. I didn't get into any of that today.

Just for the base-year 2000, ALFRED offers eleven different vintages. The oldest is dated September 13, 2004, and the newest August 27, 2009. That period includes the time of the financial crisis, so I figured I'd look at that.

Graph #1

Move your mouse up and down over the legend to highlight different lines on the graph. You will see that as the mouse moves down toward newer vintages, the highlighted Potential GDP line on the graph is most often lower also.

My Google Drive Spreadsheet is available.

Friday, March 8, 2013

8 + 2 = 10

Graph #1 Source: CBO PDF February 2013

Graph #2 Source: Wikipedia (CBO 2009)

Pretty easy to find graphs that looks like these, graphs that show GDP climbing back to its potential and closing the gap.

You know why the graphs show the gap closing? It's because the people who come up with the numbers just assume the gap will close within ten years! As a CBO background paper observes:

CBO assumes that any gap between actual GDP and potential GDP that remains at the end of the short-term (two-year) forecast will close during the following eight years.

Unfortunately, while the graphs show GDP recovering, there are people who say that GDP is *NOT* going to climb back up to potential. Jim Bullard says it:

I want to now turn to argue that the large output gap view may be conceptually inappropriate in the current situation. We may do better to replace it with the notion of a permanent, one-time shock to wealth...

The wealth shock view puts a different expectation in play. The negative wealth shock lowers consumption and output. But after the recession ends, the economy simply grows from that point at an ordinary rate, neither faster nor slower than in ordinary times. It is more like an earthquake which has left one part of the land higher than another part. There is no expectation of a “bounce back” to a higher level of output after the recession ends. This is closer to what has actually happened since mid-2009. Output has grown at a moderate rate, but not a rapid rate, since the recession ended.

Thomas Hoenig seems to have said it even before Bullard.

And Scott Sumner is clearing his throat:

In 2009 I advocated going all the way back to the old trend line. I currently favor going about 1/3 of the way back. If we keep on the same track for a few more years I’ll through in the towel and advocate starting a new 5% trend line from where we are.

Stranger than fiction, people who are not saying what Bullard says, people like William Gavin and David Altig, are showing graphs where instead of GDP moving up to trend, the trend of potential output keeps getting lower!

Those graphs that show GDP will recover soon, well, "soon" is always just a little out of reach, and even the people who present those graphs seem not to believe them.

The Consequences of Denial

From mine of 13 Feb 2012:

Anyway, Bullard. He says if we overestimate potential output and set policy by it, we will encourage excessive demand and we will get inflation like we got in the 1970s. (And, he says, inflation is already above target.)

Everybody else says the economy is not growing enough, and we don't have jobs enough, and unemployment is too high, and demand is insufficient, not excessive.

How can there be such a difference in views? I think the trouble arises from the way we explain inflation. Here's Mitchell again:

Inflation is driven by nominal aggregate demand growth that exceeds the capacity of the economy to respond in real terms – that is, to increase output.

Too much money chasing too few goods. For Billy, as for Milton and Anna, inflation is caused by excessive demand -- by demand "that exceeds the capacity of the economy to respond". Demand being excessive relative to potential output is the cause of inflation, they say. Exactly what Jim Bullard says.

If you think of inflation along those lines, and you admit we're getting inflation already, then you end up thinking that "the capacity of the economy to respond" must somehow have been crippled. You end up thinking that there must have been a sudden drop in potential output. Exactly what Jim Bullard says.

But all we need -- if we wish to undermine Jim Bullard's argument -- is to realize that demand-pull isn't the only inflation story there is. There is also a cost-push inflation.