Just checking

Responding to their critics, R&R link to their data from This Time Is Different. I visited their data.

I browsed by country, clicked on the United States, and clicked on Debt to GDP Ratios. Nothing seemed to happen, so I clicked it again. Then I checked my downloads folder and found two copies of their Excel file.

Then I bothered to read the twice-clicked Debt to GDP Ratios line: Debt to GDP Ratios country T-Z.xls, it says. See those last three letters there? XLS? I might have known it was downloading an excel file, if I read all the way to the end.

Well, that's all the funny stuff for today.

So I looked at the file. It defaults to a Contents sheet identifying the authors (a useful detail) and lists the countries for which the numbers are presented on other sheets; that's a nice touch.

I went right away to the US data. The data sources are identified, and three columns of Debt/GDP numbers are provided, along with a "Year" column, of course.

The three different measures are

1. Total (domestic plus external) gross central government debt/GDP (1790-2010)
2. Total (domestic plus external) gross general government debt/GDP (1980-2010)
3. Total (public plus private) gross external debt/GDP (1970-2010)

I want to see how these measures compare to FRED's "Total Credit Market Debt Owed" (TCMDO), to the Federal government's portion of TCMDO, and to the Gross Federal debt. To make the comparison I'll show the FRED measures as debt/GDP, the same as Reinhart and Rogoff do.

The FRED numbers are all annual data, same as R&R. The start dates on the FRED numbers vary. Three of the series start at 1950, one at 1939. So I deleted R&R values from before 1939, leaving a minimum of two series to look at:

FRED's "Total Credit Market Debt Owed" (Green) Towers Above All the Rest

The R&R debt numbers most certainly do exclude most of the debt in the US.

One other interesting thing on this graph: a significant increase in US "external" debt, as shown by the "R&R External" item.

Do we really want to wait till things are that bad?

Via George Washington's blog at ZeroHedge, Reinhart and Rogoff: Responding to Our Critics by Carmen M. Reinhart and Kenneth S. Rogoff:

Researchers at the Bank of International Settlements and the International Monetary Fund have weighed in with their own independent work. The World Economic Outlook published last October by the International Monetary Fund devoted an entire chapter to debt and growth. The most recent update to that outlook, released in April, states: “Much of the empirical work on debt overhangs seeks to identify the ‘overhang threshold’ beyond which the correlation between debt and growth becomes negative. The results are broadly similar: above a threshold of about 95 percent of G.D.P., a 10 percent increase in the ratio of debt to G.D.P. is identified with a decline in annual growth of about 0.15 to 0.20 percent per year.”

This view generally reflects the state of the art in economic research...

Let me shorten that up and say it again:

“Much of the empirical work on debt overhangs seeks to identify the ‘overhang threshold’ beyond which the correlation between debt and growth becomes negative...”

So the focus of state-of-the-art economics is to find the point where adding one more dollar of debt stops making GDP go up and starts making GDP go down.

What possible object could there be to that effort? It can only be so that we might manage to come as close as possible to the threshold without crossing it. That may be state of the art, but it sure ain't the state of Arthurian.

Look: Debt productivity has been declining for a long time. The increase in GDP we get per dollar of new debt has been declining for a long time. And that's not just Federal debt. It's all of our debt. Increasing debt makes economic performance decline.

If it is true that increasing debt makes economic performance decline, then why would we want to push it close to the limit where "the correlation between debt and growth becomes negative"? This is like saying "Adding more debt is not okay if it takes away even a tiny bit of GDP, but it is okay as long as it adds to GDP, no matter how little it adds."

But it's not okay with me. As I see it, our economy can grow at maybe 4% per year. If it's only growing 3% I look first to accumulating debt to account for the 1% loss of growth. If it's only growing 1.5% I look first to accumulating debt to account for the 2.5% loss of growth. If the economy crosses the threshold and growth "becomes negative" at -0.1% say, then I look first to accumulating debt to account for the 4.1% loss of growth.

The point is, it's not okay to get one or two percent growth. It's not okay to keep getting less and less growth while more and more debt accumulates, and then only stop just short of zero growth. It's not okay. We need to stop debt accumulation when it starts to hinder growth; this is how we define the maximum acceptable level of finance for our economy. A level of finance something like we had in the 1960s, the early 1960s, is my target.

So the state of the art in economics seems to disagree with me: They are wrong.

And just to be clear on this: When I say "I look first to accumulating debt" to account for the loss of growth, I don't just mean the Federal debt. I mean all of our debt.

Other Things Equal

Partial derivative

From Wikipedia, the free encyclopedia

In mathematics, a partial derivative of a function of several variables is its derivative with respect to one of those variables, with the others held constant...

I first ran into the phrase ceteris paribus many years ago in Maynard's General Theory. It means "other things equal" or "everything else unchanged". It lets you consider the effect of a change in one factor, uncomplicated by the fact that everything in the economy is related to everything else.

Ceteris paribus

From Wikipedia, the free encyclopedia

A ceteris paribus assumption is often fundamental to the predictive purpose of scientific inquiry. In order to formulate scientific laws, it is usually necessary to rule out factors which interfere with examining a specific causal relationship...

One of the disciplines in which ceteris paribus clauses are most widely used is economics, in which they are employed to simplify the formulation and description of economic outcomes. When using ceteris paribus in economics, assume all other variables except those under immediate consideration are held constant.

(Hesitantly) Okay...

According to the Wikipedia article, the concept is used "to consider the effect of some causes in isolation, by assuming that other influences are absent."

But you have to remember it's an assumption. The purpose of "other things equal" is to help to focus on the one topic under consideration, and for that it is most effective. But it's only an assumption, not the reality. If you happen to be arguing (PDF) that "average growth falls considerably" when government debt reaches "a threshold of 90 percent of GDP", it helps to assume that nothing else is changing. So then, the results that you see can only have been caused by the cause you describe.

If we are looking at increasing debt as the cause of slowing growth, and you want to focus on the Federal debt as the cause, then you have to assume that debt other than Federal debt didn't change at all. Because if "other" debt increased a little, it may share a little of the blame for slowing growth. And if other debt increased as much as Federal debt, it may share equally in the blame. But if other debt increased more than Federal debt, perhaps it is "other" debt that should get most of the blame for slow growth.

In the graph below, the blue line shows the gross Federal debt as a percent of GDP. The red line shows "other" debt as a percent of GDP. The green line is a benchmark showing 90% of GDP.

Graph #1: Debt as the Cause of Slow Growth

Assume there was no increase in debt other than Federal, and we can say the Federal debt must be responsible for slow growth. But I just can't bring myself to say it.

How can you even know if it's not a problem?

"Not One Word"

From Ash and Pollin's response to "Reinhart-Rogoff Data Problems":

For starters, let's just be clear that there is not one word in our paper that suggests that one should never, categorically, worry about high sovereign debt loads.

They are quite clear, I think. And they make a good point: It is important not to write things off, not to simply dismiss things that could be a problem, not to be categorical about things, ever.

Crossing 90

The blue line on the graph below shows Gross Federal Debt relative to GDP. That's the thing that may or may not become a problem when it crosses 90%, per Ash and Pollin.

The green line is 90%.

The red line is the problem.

BLUE: Gross Federal Debt as a Percent of GDP
RED: Debt Other Than Federal Debt, as a Percent of GDP
GREEN: Shows 90% of GDP

A Thing Unseen

At Econbrowser, James Hamilton reproduces Reinhart and Rogoff's summary of differences in the bottom-line claims between their "Growth in a Time of Debt" paper and the Herndon/Ash/Pollin takedown paper:

1945-2009
	RR AER (2010)		HAP (2013)
Debt/GDP	Mean	Median	Mean	Median
0 to 30	4.1	4.2	4.2	NA
30 to 60	2.8	3.9	3.1	NA
60 to 90	2.8	2.9	3.2	NA
Above 90	-0.1	1.6	2.2	NA
RR AER (2010) (Table 1)
1800-2009
0 to 30	3.7	3.9	NA	NA
30 to 60	3.0	3.1	NA	NA
60 to 90	3.4	2.8	NA	NA
Above 90	1.7	1.9	NA	NA
RRR JEP (2012),
1800-2011	Mean
Below 90	3.5
Above 90	2.4

What's missing from all these numbers?

There is absolutely no reference to private debt. It's all a look at public debt. All of it. And let me point out, not only Reinhart and Rogoff but also Herndon, Ash and Pollin ignore private debt. As does James Hamilton.

How are you gonna solve a problem if you never look at it? How can you even know if it's not a problem?


Related post: Growth in a time of icebergs

A second look

Marcus takes a second look at government spending relative to GDP, and its relation to economic growth.

It may be easier to see the circularity in Marcus's analysis if I say he is looking at government spending relative to GDP, and its relation to changes in GDP. For if we're looking at changes in GDP, those changes will have to have an impact on the ratio called "government spending relative to GDP".

Marcus has an interesting approach. He considers a long period (1960-2007) and looks at government expenditure as a percent of GDP at the start and end of the period. He then looks at RGDP growth near the start and near the end of the period.

He looks at data for a dozen countries. I will look at just one of them. The US was at the top of his list of twelve, as this clip shows:

Part Screen Capture of Marcus's Table

I took Marcus's Gov. Expenditures (GX) numbers along with start- and end-year RGDP values from FRED, put them into a Zoho spreadsheet, and calculated US government expenditures in inflation-adjusted dollars.

// UPDATE: After a recent Zoho update, their spreadsheet now "takes the focus" when the page loads, and the screen jumps to make the Zoho sheet visible on-screen. Took me a few days to figure out a fix for this. I put the Zoho sheet into a "spoiler" that remains hidden until you click this text to make the Zoho sheet visible... (I'm disabling the spoiler.)

//UPDATE: But now it never loads... I'm about to give up on Zoho.

//UPDATE 7 May 2013: IT WORKS!!!!! Thank you, Zoho Support.



Then I took Marcus's Real GDP Growth numbers and put them on row 8. And I said to myself: I wonder how things would have looked if RGDP growth stayed at the high rate of the early years, 4.3% annual, rather than dropping off so much...

So I took the start-year RGDP value and Marcus's annual growth rate and put them into a compound-interest formula from Chron to see what the end-year value of RGDP would be in 2007, after 47 years. (Cell E10.)

You can check my math. I think it's good.

Anyway, after 47 years of 4.3% growth RGDP would have been 20 460 point 6. With the less impressive growth that we actually had, RGDP was 13 206 point 4. So, 20 versus 13, a pretty big difference.

So now we can take the government expenditure number for 2007 from cell C5 and look at it as a percent of the impressive RGDP number, and compare that to Marcus's GX/GDP number in cell C3.

Okay. Back in 1960 GX was 28.4% of GDP. Then, given the suck-ass GDP growth that we had for the last 40 years, in 2007 GX was way up high, at 36.7% of GDP. But if growth had continued at the early-years rate, US government expenditures would have fallen from 28.4% to 23.7% of GDP.

And I'm not fiddling with the government spending numbers. Just looking at what-if growth. So what I'm saying is that US government expenditure growth slowed since 1960, just not as much as GDP growth slowed.

How we get from that, to the idea that increasing government expenditure is the cause of slow GDP growth, the logic escapes me.

I See Red

Marcus quotes Wolfgang Munchau quoting Olli Rehn:

“Carmen Reinhart and Kenneth Rogoff have coined the ‘90 per cent rule’,” he said. “That is, countries with public debt exceeding 90 per cent of annual economic output grow more slowly. High debt levels can crowd out economic activity and entrepreneurial dynamism, and thus hamper growth...”

High debt levels can crowd out economic activity.

It's true, you know. Debt is a problem. Look at the graph:

Graph #1: Debt, debt, and Best-Case Growth
Blue: Gross Federal Debt as a Percent of GDP
Red: Debt Other Than Federal Debt, as a Percent of GDP
Green: Percent Change in Potential GDP as a Measure of Best-Case Growth

The blue line (after about 2010) is what concerns Carmen and Ken.

Me? I see red.

without the pleadings of self interest

"Time doesn’t run backwards."

This is the best put-down I think I've ever seen, of "expectations" in economics. From Steve Roth:

... cause really does almost always precede effect. Time doesn’t run backwards. (Unless you believe, like many economists, that people, populations: 1. form both confident and accurate expectations about future macro variables, 2. fully understand the present implications of those expectations, and 3. act “rationally” — as a Platonic economist would — based on that understanding.)

But while I'm on the subject of expectations, I want to round up some excerpts from Maynard. From The General Theory, Chapter 5: Expectation as Determining Output and Employment:

ALL production is for the purpose of ultimately satisfying a consumer. Time usually elapses, however — and sometimes much time — between the incurring of costs by the producer (with the consumer in view) and the purchase of the output by the ultimate consumer. Meanwhile the entrepreneur (including both the producer and the investor in this description) has to form the best expectations he can as to what the consumers will be prepared to pay when he is ready to supply them (directly or indirectly) after the elapse of what may be a lengthy period; and he has no choice but to be guided by these expectations, if he is to produce at all by processes which occupy time.

... It is upon these various expectations that the amount of employment which the firms offer will depend. The actually realised results of the production and sale of output will only be relevant to employment in so far as they cause a modification of subsequent expectations...

It would be too complicated to work out the expectations de novo whenever a productive process was being started; and it would, moreover, be a waste of time since a large part of the circumstances usually continue substantially unchanged from one day to the next. Accordingly it is sensible for producers to base their expectations on the assumption that the most recently realised results will continue, except in so far as there are definite reasons for expecting a change.

So the rule is that expectations are based on existing conditions (or "recent results").

For the world's economists, everything depends on expectations. For me, expectations depend on the results we're getting now.

Which come first? Easy. Results come first. Results set the standard.

Graph #1: US Real GDP Growth Rate Since 1975

See that high spot there, that big peak just before 1985? That was expectations. That's what we got from electing Ronald Reagan. Everybody had great expectations.

But it didn't last. Look at the graph. Everything since 1985 stinks.

// update, 4:03 AM

By coincidence, Marcus yesterday showed this graph,

Graph #2, Source: Marcus Nunes

He pointed out the low spot in it, and wrote:

I wonder if the July 1932 ‘bottom’ is associated with FDR´s nomination acceptance speech on July 2, 1932.

Yes to that. I think that's how "expectations" works. You get a great surge of optimism or pessimism that cannot last long. Cannot last, because it's based on expectations rather than on economic fundamentals like cost. You get a trend anomaly and that's about it.

Checking my work

In ‘Keep it simple’, Marcus Nunes writes:

I may be missing something vital, but what bothered me about the R&R ‘fall-out’ was that the original study was concerned with public debt/GDP levels. The major finding of the critics was that, contrary to the original study, no ‘tipping-point’ (after which growth is negatively affected) was found.

My take: Debt results from deficits. Deficits follow government spending (given revenues). So why not go to the ‘source’, i.e., government spending, and check if it has a measurable impact on growth.

My kneejerk was to object to this simplification: "Debt results from deficits. Deficits follow government spending (given revenues)."

I'm not saying it's not true. It's simple arithmetic: If you spend more than your income, you have a deficit. If A is less than B, then A-B is less than zero. But it makes me cringe because there's no economics in it.

Marcus isn't the only one to look at deficits this way. People commonly look at deficits the way Marcus does in the excerpt. But it ignores all of the economic forces that may have come into play, forces that may have held back GDP growth, held back income growth, and held back tax revenue growth on the one hand. And on the other it ignores all the forces that may have worked themselves out by demanding the expansion of government spending.

No. Instead of that, we have B is greater than A.


And then I thought about my objection to Milton Friedman's MRTO graphs. Friedman compares "the quantity of money relative to output" to the price level, and finds great similarity.

My objection to Friedman's graph is that he forces the price level into the "money to output" ratio by removing the price level from the denominator of that ratio. The similarity that appears in the graph is due to circularity in the arithmetic. The similarity is manufactured by the calculation.


So Marcus relies on simple arithmetic to analyze deficits, and I object to that. On the other hand, Friedman ignores the simple arithmetic that invalidates his MRTO graph.

Friedman describes economic forces and I object based on simple arithmetic. Nunes uses simple arithmetic and I object based on economic forces.

I don't know what to make of this, but I want to think about it some.


Well that was easy.

Friedman relies on economic forces to show what he shows. But simple arithmetic shows the circularity that invalidates his work.

Nunes relies on simple arithmetic to show what he shows. But he ignores the economic forces that describe what is really going on.

Two factors that are important for growth

Yesterday I quoted two paragraphs from Simon Wren-Lewis, expressing two ideas.

The first paragraph described a relation between "contraction in government spending" and the lack of economic recovery.

The second pointed out that a high level of government debt creates a barrier preventing the expansion of government spending sufficient to generate economic recovery.

I suggested that the way to deal with these two facts, assuming they are facts, is to reduce private sector debt. Private debt reduction accomplishes the same thing as increasing government spending: It reduces the ratio of private to public debt.

I don't get into why reducing that ratio is important; the reason probably has to do with sectoral balances. That's not my area. But I have shown repeatedly on this blog that reducing the ratio is an effective (read: necessary) way to boost economic growth.

I've also shown a relation between debt relative to circulating money and economic performance. You can't read this blog without tripping over my "Debt per Dollar" graphs.

What I'm saying is this: Two factors are important to growth. One is the balance between public and private debt. The other is the level of total accumulated debt relative to the quantity of circulating money.


So I was thinking about this. I have two factors, two ratios. The one is the ratio of private to public debt, something I've considered several times here. The other is the level of debt, per dollar of circulating money. I've looked at that a lot, too. But I never looked at the ratio of these two ratios.

1. The ratio of private to public debt:

Ratio #1: Total debt (TCMDO) less its Federal component, relative to Gross Federal debt.

2. The level of debt per dollar of circulating money:

Ratio #2: Total Debt, relative to Circulating Money
Blue: Relative to M1SL (excludes "Sweeps")
Red: Relative to M1ADJ (includes "Sweeps")

(I use M1ADJ, the honest measure after 1994. To display the maximum number of years, I show M1SL for the early years (1959 thru 1995).)

3. The ratio I've not looked at before, which is Ratio #1 relative to Ratio #2:

Ratio #3: The Ratio of Private to Public Debt, Relative to Debt per Dollar

Ratio #3 shows increase during the "golden age" which ended with the 1974 recession.

It shows decline from 1974 to the 1990s. The decline shows what Scott Sumner says: "I am not denying that growth in US living standards slowed after 1973". It shows what Ross Perot showed, back in 1992: decline for two decades after 1973.

The ratio shows increase from 1995 to the 2001 recession, a time when the economy's performance has been called a macroeconomic miracle.

The ratio shows decline thereafter.


The ratio of ratios goes up during the good economic performances from the 1950s to 1973 and from 1995 to 2000. Otherwise it goes down.

The ratio of ratios compares two factors that are important for growth: the ratio of private to public debt, and the ratio of debt to circulating money.

I really shouldn't have to write any more. This should be the blog post that ends all debate regarding economic performance. Study these graphs till the cows come home.

Something else entirely

Simon Wren-Lewis describes events since 2008:

Go into detail within the advanced economies group, and the pattern is clear: the greater the contraction in government spending relative to previous recoveries, the slower the recovery has been.

Their analysis also shows us one of the reasons why this happened. The advanced economies started the recovery with debt to GDP almost twice its average level in previous recoveries.

So the lesson here is that having lots of government debt is bad because if the economy turns to shit, the government is handicapped by its debt. The government is prevented from enlarging its deficit spending to fight recession because of the size of the debt it already has.

Yes, okay, if you insist: The government is prevented by wrong-headed fools from enlarging its deficit spending to fight the recession. Feel better now?

Don't you see it doesn't do any good to look at things that way? They don't think they're wrong. (Actually, they think you are wrong.) And they obviously have the upper hand, for we are in fact prevented by them from the enlargement of deficit spending enough to create a recovery.

So maybe it's not them that are the fools, after all.


What did I say?

The government is prevented from enlarging its deficit spending to fight the recession, because of the size of the debt it has already.

I think that's an accurate description of what happens.

And I think there's some merit to it. You know better, I know you do. The government debt's not the problem. You know it. I know it too, but that doesn't get us anywhere.

See, here it is: You say the government debt is not the problem. But the other guys say the government debt is not the solution.

You say the government debt is not the problem, but you mean you want to use government debt as the solution.

The other guys know government debt is not the solution, because we already have very very much of it, growing since Reagan (though they may not actually say "since Reagan"), this massive government debt, and despite all that debt the economy is garbage, no better than garbage.

So, with some justification, they think that expanding the government debt is not even worth considering. Even though you know that government debt is not the problem.

And even though you are right.

But it is one thing to say government debt is not the problem. And it is something else entirely to say government debt is the solution.


Excessive private debt stands in the way of economic growth. Our goal must be to reduce private debt.

Zoho it is, then

Konczal's R&R screen clip, again:

I put the country names and the debt/GDP values from Konczal's clip into a Zoho spreadsheet so we can play with it online. You can edit the zoho and see the results (and even save it as an Excel file if you want, apparently). You won't mess up my Zoho sheet. If you refresh the page, all your changes go away.



Look in particular at the values on Zoho row 29. These are the R&R error cells. Click on Cell B29, then look up at the top line of the Zoho to see what the formula is. It says:
=AVERAGE(B4:B18)
Here's what I want you to do: With Cell B29 selected, press DELETE to erase the formula. Now, type the EQUAL sign and the word AVERAGE and then open parenthesis (that's SHIFT 9 on my keyboard). Next, click Cell B4 and hold the mouse button down, then drag down to row B23. Release the mouse button. Press ENTER.

Zoho closes the parentheses for you, and calculates the average value for the cells you selected. The cell value changes.

On my computer when I do the next step the screen jumps. Just scroll back so you can see everything again.

Select Cell B29 again, and press CTRL C to copy the formula you entered.
(Scroll the screen if necessary, but don't click or type anything.)

Select cells C29 through E29 and press CTRL V to paste your formula into those cells. The values change because of your new formula.

You did it! You fixed R&R's error!

The Same Old Story

Two days ago I wrote:

Growth was slowing the 1970s, Sumner says.

Sure, because the Fed kept creating recessions to slow things down. Because of the inflation.

But the problem was not that growth was slow. Slow growth was a policy goal in the 1970s. If growth was slowing in the 1970s, it was a policy success. It is utterly wrong to turn that around now and pretend that slow growth was the problem.

Sumner is analyzing the wrong problem. They all are.

Yesterday I wrote:

The problem in those years was not that we couldn't get good growth. And the problem was not that we couldn't keep inflation at bay. The problem was that we could not do both at the same time.

In 1977 I wrote:

The problem that was so magnificently solved during the 1960s was the either/or cycle, of inflation and unemployment. The problem of the '70s, as we well know, is not either/or, but both. Stagflation, it has been called; a new name, describing a new problem.

For nearly a decade, we have been trying to solve a "both" problem with "either/or" solutions. Little wonder we have met with little success in the '70s!

In order to solve the economic problem, we must know what the problem really is.

Wrong Problem Redux

Let me pull out from yesterday's post several bits of excerpt from Scott Sumner. I'm taking everything Sumner after the topic-phrase "US growth before and after 1980".

There's one little piece I don't need today; I scratched it out.

Sumner, in yesterday's sequence:

Growth has been slower [since 1980], but that’s true almost everywhere. What is important is that the neoliberal reforms in America have helped arrest our relative decline...

...neoliberal reforms lead to faster growth in real income, relative to the unreformed alternative.

The neoliberal revolution occurred precisely because growth was slowing almost everywhere in the 1970s and 1980s, and after 1980 growth slowed the most in those countries that reformed the least.

And his summary:

I am not denying that growth in US living standards slowed after 1973, rather I am arguing that it would have slowed more had we not reformed our economy.

So what is Scott Sumner saying, really? Seems to me he says two things. He says there was a problem: Growth was slowing in the 1970s. And the second thing he says is that the neoliberal reforms "helped arrest our relative decline". I have problems with both of these statements.

First of all, the reforms did not solve nor even partially solve the problem. Making the economy grow faster is not the same thing as eliminating the cause of slow growth. The latter is a solution. The former is a tweak.

The problem was never solved. The neoliberal reforms used several work-around techniques to compensate for the problem of slow growth. Even if the reforms fully compensated for the decline, which Sumner admits they did not, the underlying problem would not have been solved by work-around reforms.

Secondly, what was the underlying problem? "Growth was slowing," Sumner says. I do not agree that slowing growth was the problem. Not in the 1970s. Look at this graph from Marcus Nunes:

Graph #1 Source: Marcus Nunes

Marcus shows inflation-adjusted GDP on a log scale, so that a constant growth rate appears as a straight line. In red, he shows a constant-rate trend line. And he marks up the graph to identify different periods. I wish to focus on the period labeled "G.I." for "Great Inflation" -- the inflationary years from 1965 to 1980.

Marcus's graph shows the blue line at or above trend for the entire inflationary period. By contrast, before 1965, and again after 1980, the blue line is at or below trend. The inflationary period seems to show particularly good economic performance. I find this odd, because Sumner (and everyone) says growth was not good in the 1970s. Sumner says "growth was slowing". Marcus's graph does not agree.

(Yes I know, there was inflation in those years, and it was a problem. But an inflation problem is not the same thing as a slow growth problem. And neither of those is the same as our actual problem, which was that better growth would come only with more inflation. We could no longer separate the two.)

Growth was well above trend in the inflationary years. But perhaps being above trend is not the same as good economic performance? I went to FRED, duplicated Marcus's graph, and added a trend line by eye, matching as best I could Marcus's red line from Graph #1:

Graph #2: Inflation-Adjusted GDP (blue) on a Log Scale with a Trend Line Added by Eye

The FRED graph shows recessions as gray bars, so now we can see that the recession of 1970 brought the blue line down to trend, as did the 1974 and 1980 recessions, and the 1982 recession brought it below trend. But apart from times of recession, in the 1965-1980 period the blue line tends not only to run above trend, but also to pull away from trend. To increase more rapidly than trend. To grow faster than trend. Repeatedly, each time until the Fed restrains growth to combat inflation.

Looks to me like growth was very good in those years. Too good, you might say. Maybe so, but that is not what Sumner says. "Growth was slowing", Sumner says.

You can't have it both ways.

The real problem was not that growth was slowing in the 1970s. We were getting good growth. The problem was, we couldn't get good growth without inflation. Growth could easily have remained vigorous, if we were foolish enough to accept the inflation.


The problem was not that growth was slow. We could have fixed that by the traditional methods. Nor was the problem inflation. We *did* fix that by the traditional methods. The problem was that the range of good options narrowed and then disappeared. The economy changed. There was no longer a golden zone where we could have decent growth and reasonable price stability at the same time. This was the problem.

To put it in terms an economist might understand, the Phillips curve shifted away from the origin.

The problem in those years was not that we couldn't get good growth. And the problem was not that we couldn't keep inflation at bay. The problem was that we could not do both at the same time.

That much remains true today.

Four times they call it a "coding error"

From WSJ: Reinhart, Rogoff Admit Excel Mistake:

Herndon, Ash and Pollin accurately point out the coding error that omits several countries from the averages in figure 2.

If you're not so hot with Excel, I guess you could call it a "coding" error. It's a goddam click-and-drag mistake, that's all it is. An embarrassingly amateurish mistake.

Here's the thing: When they selected the values for a list of 20 countries, they missed the last five values. Konczal has a screen clip:
New link for the Konczal post, 25 April 2018

See the dark blue rectangle with a dot in each corner? Column L, rows 30 to 44. That's a "range" of cells that somebody used in a calculation.

What calculation? Lower right corner, Cell L51, the calculation begins with an equal sign and takes the average value of the cells in the dark blue box.

The blue box should have gone all the way down to row 49. If it did, it would have included one more actual value. Would it have made much difference? I don't know. But the cell-selection would have been right, at least.

If I made a mistake like that in a spreadsheet at work, the boss would somehow figure it out right away and I'd get reamed for it, fairly. And then we would go back to work. So should y'all now.


Having gone back to work myself, the focus of this post changes.

Last December, in Simulacron: Make that three trends I showed this graph of inflation-adjusted GDP with three different trend paths:

Graph #1: Stages of the slowdown in real growth

I wrote:

By the fourth quarter of 2007 when real GDP reached 13.3 trillion, blue trend GDP was 17 trillion, more than 25% greater.

Twenty-five percent.

In the "R&R Admit" post linked at the top, Reinhart and Rogoff write:

It is utterly misleading to speak of a 1% growth differential that lasts 10-25 years as small. If a country grows at 1% below trend for 23 years, output will be roughly 25% below trend at the end of the period, with massive cumulative effects.

Twenty-five percent. Reinhart and Rogoff got this one right, guys.

Give 'em a break.

// 10:54 pm Update:

Come to think of it, the Gross Federal Debt fell from over 90% of GDP in the late 1940s to just over 30% in 1974, skidded along the bottom until 1981, and then started going up:

Graph #2: Gross Federal Debt as a Percent of GDP

According to Graph #1, the economy grew with vigor until the Federal Debt reached a low point. And then, with Federal debt at a low, the economy lost its vigor. And for the three decades since the early 1980s the economy grew about 1% slower than in the three decades before the early 1980s.

So according to these two graphs, one could say it was the lowness of the Federal debt that caused the slowdown in economic growth.

And as Reinhart and Rogaine point out, a long period of 1% slower growth has "massive cumulative effects".

What everybody seems to miss in all of this, is that when the Federal debt was high in the early years of Graph #2, private debt was at a low point. Today the Federal debt is high again, and private debt is also at a high point.

In the early years, accumulated private debt did not interfere with private sector growth. Today it does.

Ya just gotta laugh

From WSJ's Reinhart-Rogoff Response:

On a cursory look, it seems that that Herndon Ash and Pollen also find lower growth when debt is over 90%...

Wrong Problem

Background post: Economic Performance: The Record.

Old Krugman, May 24, 2010, 3:31 pm:

Did The Postwar System Fail?

I’ve been posting about the contrast between the popular perception on the right that America had slow growth until Reagan came along, and the reality that we did fine pre-Reagan, in fact better; see here, here, and here.

I went looking there, there, there, and at my regular hangout.

May 22, 2010: Krugman paraphrases Richard Green, saying "growth has actually been slower since the big rightward shift circa 1980." And he shows a graph of median family income suddenly slowing down circa 1968.

May 23, 2010: Same graph, and this note: "...if you look at income per hour it’s actually worse than the median income."

May 24, 2010: Well, here's something:

Scott Sumner says that I’m wrong about taxes, regulation, and growth, because although American growth has slowed since deregulation and all that, the growth has been better than we might have expected.

We can try to parse whether that’s true — but in any case it’s not a response to my original point. That was about the claim, quite common on the right, that the US economy was stagnant until Reagan did away with those nasty New Deal policies...

So then, Sumner:

For those of you not old enough to remember 1980, let me explain... There was garbage piling up in the streets of London. Britain had been the sick man of Europe for decades, growing far more slowly than Germany, France and Italy. The US wasn’t doing as badly, but certainly wasn’t doing that well either. We had also been growing much more slowly than Europe and Japan...

Krugman makes the basic mistake of just looking at time series evidence, and only two data points: US growth before and after 1980. Growth has been slower, but that’s true almost everywhere. What is important is that the neoliberal reforms in America have helped arrest our relative decline...

...neoliberal reforms lead to faster growth in real income, relative to the unreformed alternative.

Yep: Scott Sumner says American growth has slowed since deregulation and all that, but that the growth has been better than we might have expected otherwise had.

Then, finally, some meat. Sumner says:

The neoliberal revolution occurred precisely because growth was slowing almost everywhere in the 1970s and 1980s, and after 1980 growth slowed the most in those countries that reformed the least.

And this:

I am not denying that growth in US living standards slowed after 1973, rather I am arguing that it would have slowed more had we not reformed our economy.

As for myself, I'm not denying that Supply Side economics helped boost the supply side. I'm just saying it didn't solve the problem.


On a related note, I have a problem with Scott Sumner's analysis. Growth was slowing in the 1970s, Sumner says.

Sure, because the Fed kept creating recessions to slow things down. Because of the inflation.

But the problem was not that growth was slow. Slow growth was a policy goal in the 1970s. If growth was slowing in the 1970s, it was a policy success. It is utterly wrong to turn that around now and pretend that slow growth was the problem.

Sumner is analyzing the wrong problem. They all are.

John Law's Financial System... It sounds oddly familiar

From Famous First Bubbles (PDF, 1990, 20 pages) by Peter M. Garber:

John Law's Financial System

Both the Mississippi and South Sea Bubbles can be best understood in the context of the monetary theory and system created by John Law. Law is not well-known today, but Schumpeter (1954, p.295), for example, is unreserved in praising him: "He worked out the economics of his projects with a brilliance and, yes, profundity which places him in the front ranks of monetary theorists of all times."

Law (1705) sketched a monetary theory in an environment of unemployed resources. In such an environment, he argued (1760, pp. 190-91), an emission of paper currency would expand real commerce permanently, thereby increasing the demand for the new currency sufficiently to preclude pressure on prices.

From the Journal of Economic Perspectives -- Volume 4, Number 2 -- Spring 1990. Via Reddit, submitted by timhuge. (Highlighting mine.)

Jim Tankersley: "Is slow growth America’s new normal?"

At the Washington Post, Jim Tankersley:

Still, many economists, even the ones holding to the “bad luck” story, agree that something has changed in the economy post-recovery; our fireballer, they say, appears to have lost some speed on his fastball permanently. The easiest way to see that is in prices... Prices aren’t rising very fast, even with aggressive monetary easing, but the fact that they aren’t falling probably suggests the demand void — the untapped potential in the economy — isn’t as big as forecasters once thought.

No.

First of all, the argument is based on prices. As if economists understood the forces that drive prices. Tankersley tells the same old "demand-pull" story, the same story you get everywhere from Friedman and Schwartz to Bill Mitchell. But demand-pull stopped being the correct story just about the time Friedman and Schwartz published their book in 1963.

To understand what drives prices now, you have to think cost-push. You have to figure in the cost of finance. You have to allow for the drag, allow for the sluggishness created by the cost of finance. And then you have to allow for all the policy fixes put in place since stagflation arose in the 1970s, fixes that mostly reinforced the problem.

To say that prices aren’t falling "suggests the demand void ... isn’t as big as forecasters once thought" oversimplifies the problem immensely. To say the least.

// Coincidentally related: Analyzing the present

Dunno how I missed this...

Previously, comparing the real non-Federal deficit to the size of the economy, I missed the fact it was as low in the early 1990s as it was before the mid-1960s:

Graph #1: Change in Debt Other Than Federal (Adjusted for Inflation) Relative to Real GDP

The economy was good then, in the 1950s and '60s.

After the 1986-1992 decline, the trend turned around and the economy was good again in the 1990s. Until those deficits got too big, again. And just to be clear, we're not talking Federal deficits here. We're talking everybody else's deficits.

People always say bigger is better. But with debt and deficits, bigger is more costly.

And "costly" means trouble for growth.

Average it is, then

How does FRED think? When you take a time series that's given in "quarterly" values and you change the aggregation to "annual" values, how does that work exactly?

In particular, I'm thinking of the GDP Deflator. You know: the one where the 2005 value is 100, making it easy to compare prices of other years.

GDPDEF, FRED's GDP Deflator, defaults to quarterly values. So, which of the four quarters of 2005 has the value 100??? None of them, as it turns out:

Graph #1

Second quarter is a little low, third quarter is a little high. First and fourth are worse. I figured as much. It's gotta be the annual numbers that will turn up the special value that has to be there.

But when you look at FRED's GDPDEF page and change the aggregation from quarterly to annual, an option field appears asking whether you want average, sum, or end of period aggregation. Three ways to turn the four quarterly values into the value 100. Which method will work?

I was pretty sure that "sum" would take the four values from 2005 -- all of them in the neighborhood of 100 -- and add them together to give me a result in the neighborhood of 400. And yes, that is what happens. So the "sum" option is not the one.

We are left with two options: the average of the four values, or the last of the four. When you switch quarterly data to annual aggregation, FRED defaults to average aggregation. So I figured that one would give me the value 100. But just to be sure, I plotted the data both ways:

Graph #2: Aggregation by Average of Values (blue) and by Last of Values (red)
Click Graph for FRED Source Page

The second set of red and blue of bars, second from the left, shows the blue bar right there at 100.0, and the red bar higher. For me, this confirms that the well-known GDP Deflator value 100, at FRED at least, is the average of the quarterly values.

I downloaded the numbers, just to be sure. The value for 2005 is 99.993. Close enough for government work. Funny thing, though: It's off by double-o-seven.

Analyzing the present

I got to the middle of page 2 of Christopher A. Sims' Paper Money (PDF, 40 pages) before I had my first reaction: He is analyzing how the economy works now, rather than how we got into this situation.

I don't think his is a productive approach.


Yes, actually: analyzing how the economy works now. You can see it in the opening sentence of the paper's Abstract:

Drastic changes in central bank operations and monetary institutions in recent years have made previously standard approaches to explaining the determination of the price level obsolete. Recent expansions of central bank balance sheets and of the levels of rich-country sovereign debt, as well as the evolving political economy of the European Monetary Union, have made it clear that fiscal policy and monetary policy are intertwined. Our thinking and teaching about inflation, monetary policy and fiscal policy should be based on models that recognize fiscal-monetary policy interactions.

Well, maybe, it'll be useful if it leads to an improved analysis of how we got into this situation, so that we can understand what's wrong with where we are today.


Skipping to the conclusion. Sims writes:

The kinds of models that have been the staple of undergraduate macroeconomics teaching, with price level determined by balance between “money supply” and “money demand”, and money supply described using the “money multiplier”, are obsolete and provide little insight into the policy issues facing fiscal and monetary authorities in the last few years. There are relatively simple models available, though, that could be taught in undergraduate and graduate courses and that would allow discussion of current policy issues using clearer analytic foundations.

Existing models are "obsolete", he says. They "provide little insight into the policy issues facing fiscal and monetary authorities". Sims prefers different models, ones that better describe how the economy seems to operate in the years since the crisis.

I cannot emphasize enough how wrong this is. If we base policy on current conditions, we are accepting current conditions as normal. But these are abnormal conditions. The fact that policy has so far failed to rectify the situation, and that the abnormal has continued on now for several years, does not make the abnormal normal.

It's up to you, I guess. If you want to accept higher unemployment and lower GDP growth as normal, then you will choose to look at things the way Christopher Sims looks at things. But if you want to fix those problems, then you need to look at the economy when it was good and see what changes there have been since that time, and try to work out an explanation along those lines.

// Coincidentally related: Jim Tankersley: "Is slow growth America’s new normal?"

Seeing for myself

I looked before at the Econbrowser guest post The Myth of 'Jobless Recoveries' by Laurence Ball (Johns Hopkins University), Daniel Leigh (IMF) and Prakash Loungani (IMF).

Since then I found Kurt Annen's Visual BASIC code for calculating Hodrick Prescott values. So now I can try again to duplicate the graphs from the Econbrowser post, and maybe learn more about them.

From that post:

Using annual U.S. data from 1948 to 2011, we find that the Okun’s Law has a coefficient of –0.4 or –0.5, with an R² in the neighborhood of 0.8. 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.

Chart 1. United States: Okun’s Law, 1948-2011 (Annual data) (Natural Rates Based on Hodrick-Prescott (HP) Filter with λ = 100)

NOTE: In the Econbrowser article the text reads "...a coefficient of –0.4 or –0.5, with an in the neighborhood of 0.8." Something is obviously missing between the words "an" and "in". I tracked down Laurence Ball at IDEAS, clicked the IMF link to paper, opened the PDF Okun's Law: Fit at 50?, and searched it for the phrase "coefficient of –0.4". Yup, what's missing is "R-squared", given in the PDF as capital R with an overbar, followed by a superscript 2. So I inserted that into the Econbrowser excerpt.


I went to FRED for "annual" data on "unemployment" and "output". Retrieved the seasonally adjusted Civilian Unemployment Rate UNRATE and seasonally adjusted Real Gross Domestic Product GDPC1. For both I selected "annual" data and the default aggregation method, "average". Used Excel to calculate the Hodrick Prescott values and figure the gaps -- the differences between the FRED values and the HP values. Created a scatterplot showing gap versus gap:

Graph #2

Well I'll be darned. The chart's a good match. I got my axes the wrong way around from Chart 1, but the data points are definitely grouped along the trend line, and I even got an R² comparable to the 0.8 reported in the Econbrowser post. And no major outliers.

Huh.

Okay. What I'm looking at is the difference of output values from their trend, versus the difference of unemployment values from their trend. I have to think about it a while.


Two points.

1. On my graph, the unemployment gap values range roughly from 2 to -2, or a difference of four percentage points. And the output gap values range roughly from 4 to -4, a difference of 8 percentage points. Roughly, the change in output is twice the change in unemployment. This agrees with Okun's law.

2. The output gap for this exercise is assumed to be the difference between inflation-adjusted output, and the trend of that output. In other applications, the output gap is taken to be the difference between inflation-adjusted output and potential output, which is not the same as the trend of realized output.

According to CBO's A Summary of Alternative Methods for Estimating Potential GDP (PDF),

Statistical filters (such as centered moving averages, bandpass filters, the Hodrick-Prescott filter, and the Kalman filter) are often used to extract the trend from GDP directly. These methods do not generally use Okun’s law...

Having actually used the HP filter now two or three times, having seen it for myself, I understand this better and I see it applies to the work of Laurence Ball et al. Ball's work is *not* circular because he uses an alternative to CBO's calculation, one that does not use Okun's law.

And yet, as the CBO paper states:

There are many ways to estimate the trend in GDP (and other economic data) as well as to compute the economy’s productive potential. Some methods rely on purely statistical techniques. Others, such as CBO’s method, rely on models guided by economic theory. Many methods used to compute potential output do not benchmark their trends to inflation or any independent measure of capacity and therefore cannot be interpreted as estimating the level of maximum sustainable output. That is, they provide a measure of trend output but not potential output.

If we, Laurence Ball and I, are not measuring the output gap as the difference from potential output, then we are likely understating the size of the gap.

If there is a long-term trend of decline in realized GDP, as I believe, then there may be a long-term increase in the size of the output gap that we are understating.


Thought about it. Given the actual unemployment we've had over the years, it is reasonable to draw a "trend line" that minimizes the actual variations, and helps us picture the general trend. Likewise output.

And then is is interesting to compare the differences-from-trend of unemployment against the differences-from-trend of output. This is what we see in the above graphs. There is nothing circular in the arithmetic, that I can see. And the correlation appears to be strong.


Regarding the second graph in the Econbrowser post, we read:

Our finding of a stable Okun’s Law is robust to various methods of measuring short-run movements in output and unemployment. We try alternatives to the Hodrick Prescott (HP) filter. We also estimate the relationship in “changes”, that is between the change in the unemployment rate and the change in (log) output, which does not require using the HP or any other filter. The relationship holds for quarterly as well as annual data. Chart 2 shows the tight fit between actual unemployment and the estimate based on Okun’s Law. Some residuals are evident during the early years of the Great Recession, for which Ferrara and Mignon provide some conjectures.

Chart 2. United States: Actual and Fitted Unemployment Rate, 1948Q2-2011Q4. Notes: Figure reports fitted unemployment rate from Okun specification estimated on quarterly data in levels with two lags and natural rates based on Hodrick-Prescott filter with λ = 100.

Trying to get clear on what they're saying. This part is easy: "Chart 2 shows the tight fit between actual unemployment and the estimate based on Okun’s Law." In this case, they definitely *are* using Okun's law to determine "fitted" unemployment.

The note below the graph refers to "levels with two lags" which must be some specific detail of the calculation, but the meaning escapes me.

The note below also refers to "natural rates based on Hodrick-Prescott". Rates, plural, so I think they figured HP trends for both output and unemployment, and used these somehow in their calculation. Then Okun's law comes into play. Working it backwards, they use the output gap to estimate unemployment. They call this estimate "fitted" unemployment, and they compare it to "actual" unemployment in their graph.


Okay. I think I figured out a way to estimate unemployment numbers using Okun's law and the HP trends. In my post (linked at the top) I wrote:

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

I'll do the same thing now, but reverse the direction. First I'll figure the HP trends for unemployment and GDP. Then I'll take the difference of GDP and its trend, shrink it by half -- that's the Okun's law part -- and add it to the unemployment trend, then use the result for my estimated unemployment numbers. Now it's simple.

Graph #4

Holy crap! It's a really good match.

Okay, again: Take the discrepancy between RGDP and its HP trend, shrink it by half per Okun's law, and add it to the unemployment HP trend. That's the red line. The blue line is FRED's UNRATE.

What I've learned:
1. The HP trend calc is a really good trend calc.
2. Laurence Ball's "output gap" is the difference between RGDP and its trend, without regard for inflation or the Phillips curve which play a role in the CBO calc. Ball's output gap is based on the trend of realized RGDP, not on Potential Output. This is a significant difference, but I now think not relevant to Ball's Econbrowser post.
3. Laurence Ball's calc is *not* circular, and it *is* interesting.


On Graph #4, the blue line is above the red line when actual unemployment is higher than the estimate. The blue line is lower when actual unemployment is lower than the estimate.

We like low unemployment. We like the blue line low.

Looking at Graph #4, I see two periods where the blue line is clearly below the red line for more than a very brief period. Those periods are 1960-1964 approximately, and 1994-2000 approximately. Those were both periods of exceptionally good economic growth, so we should expect the unemployment to be relatively low in those times. We should expect the blue line to be relatively low in those times.

I decided to look at the discrepancy between the two lines. I subtracted the blue line from the red. This gives me the "error" of the unemployment estimate, relative to realized unemployment.

Graph #5

For the most part, the error is within plus or minus half a percentage point. Not bad.

//

The Excel file containing my graphs and calcs is available for download from Google Drive.

Note that the file contains Kurt Annen's Hodrick-Prescott filter in Visual Basic code, and also some routines I use for formatting my graphs. If your security settings are reasonable, when you open the file Excel will warn you of a potential problem because the file contains VB code.

Excel doesn't know there's a problem. It only knows there could be a problem.

Excel lets you disable the code and open the file. But with the code disabled, the H-P filter calcs won't work and the whole thing will probably be garbage. So maybe you don't care to mess with it. But anyway, the file is available if you want.