Show and Tell: A Comparison of Contexts for Debt

Today's graph shows total debt (public and private) in two contexts. In red, debt is shown relative to GDP. In blue, debt is shown relative to circulating money. The two are similar, but each has a feature not present in the other.

The commonly used context, GDP, is often described as the "size" of the economy. We can say the red line shows debt relative to the size of the economy. Economists say GDP measures "final spending". They would say the red line shows total debt relative to final spending.

The blue line shows debt relative to circulating money, the stock of money used for paying bills. This context is relevant because "the stock of money used for paying bills" is what we use to make the payments on our debts. Creating debt creates that money. Paying down debt destroys it.

You might think the debt number and the circulating-money number are equal. For the record, they are not.


The graph follows. The bullet points below the graph present half a century of comparison of debt in the two contexts. Touch, click, or hover on the bulleted text to display markups on the graph. Scroll the white window for additional bullets.

M1 Money (blue) and GDP (red) as Context for TCMDO Debt

Before the 1990s
  •  The red line is held down by the Great Inflation from the mid-1960s to the early 1980s.
  •  The blue line is not.
  •  The red line is driven up by the winding down of inflation in the 1980s.
  •  The blue line is not.
  •  The red line might have run parallel to the blue from 1960 to 1990, if not for the Great Inflation.

The 1990s
  •  The blue line falls for a few years after 1990, reducing the financial cost borne by each dollar of M1 money.
  •  The red line does not.
  •  The blue line shows great increase after 1993, as credit use drives growth in the "Goldilocks years" of the latter 1990s.
  •  The red line shows no comparable increase.
  •  The blue line provides better information regarding the improved economy of the Goldilocks years and the changes that prepared the economy to enjoy that improved economic performance.

The Onset of Crisis
  •  Coming out of the 1990s the blue line returns to its pre-1990 trend. The red does not.
  •  When the final rush to peak occurs, it occurs first in the blue.
  •  And in the race to the peak, the blue line gets there first.

Simon Wren-Lewis warns of "the danger of presenting increases in nominal terms, where any growth may just reflect inflation." This same danger arises when we use GDP as the context for debt.

GDP measures the output of a single year. Debt measures the accumulation of many years. The value of a dollar some years back is not the same as that of a dollar today. The value of debt and the value of GDP are affected differently by inflation. The dark red line shows a disturbance that just reflects inflation.

Mistaking the effects of inflation for real change is a valid and important concern. But we must beware also the danger of choosing a ratio that fails to show real changes. In the decade after 1985 there was an unusual drop in the growth of total debt and a substantial increase in the quantity of circulating money. These changes reduced the financial cost associated with using money, and opened a door to the improved economy of the latter 1990s. The blue line shows these changes. The red line does not.

GDP is a useful context variable. But as a context for debt, circulating money is as good or better.


For more on the anomaly of the 1990s, see Four Thoughts.

For more on the financial cost of money, see Estimating the Factor Cost of Money (2).

For more on inflation and debt, see Illusion, Reality, and the Growth of Debt and the PDF Measuring the erosion of debt.

I never thought of that!

In post from 2012, Sense and nonsense about the aging of the population, Circuit considers the aging of the baby boom. The movement of boomers out of employment and into retirement reduces the size of the workforce and increases the population that must be "carried" by those still working.

I really hate discussions like that because they pit generation against generation. Bad enough we pit black against white -- poor against poor -- in our political explanations of economic phenomena. But to set young and old against each other -- to set family members against each other -- is far more troubling.

I really like Circuit's post because it helps me resolve the problem in my mind.

The problem Circuit confronts head-on is that "over the next two decades (2011 to 2030) the number of people 65 and older will rise 78% relative to those 20 and 64." (The numbers are for Canada, but the U.S. faces a similar circumstance.)

To remedy the situation, Minister Finley is proposing to raise the eligibility age to Canada's old age security program as a way to reduce future costs and preserve the "sustainability" of federal budget costs.

Seventy-eight percent. It never seemed right to me that the baby boom generation could have that big an effect. But I didn't doubt the number. And I didn't know what to do with the problem. I never thought about it beyond that.

Circuit thought about it. He says the workforce doesn't just carry retirees. He says the workforce carries everyone who's not working. And that's always how it is.

So looking at it that way,

... when the entire population is considered relative to the working-age population, we note that the ratio rises from 159% to 180% ...

In other words, the actual "burden" of aging based on current projections consists of an additional 13% more people per working-age person. This is much smaller than the 78% that is currently being mentioned by commentators and politicians.

What a relief! And -- as a baby boomer myself -- the 13% number is much more believable than 78%.

I wish I thought of that.


Today -- 24 December -- is my last day of work. I'm retiring after the Christmas party.

Merry Christmas & Happy Holidays.

"only then can we really see if rising debt is something we should be concerned about"

Simon says

Figures for aggregate personal debt should always be normalised with respect to household income, because only then can we really see if rising debt is something we should be concerned about, or just the result of growing incomes.

Lets look at that.

The first problem is to pick some appropriate data. I'm just gonna use "disposable personal income" -- personal income after taxes -- and CMDEBT, FRED's measure of household debt. I don't have good reasons for choosing these two particular series. I'm not an economist; I don't know these things. Usually I try to use the same data that the guy I quoted was using. But Simon is making a general statement and doesn't get into specific data. I'm on my own here.

At FRED I put CMDEBT over DPI, turned off the recession bars, and took five snapshots of the graph, with the mouse highlighting five different turning points in the plotted line. I cut and pasted them to get all five turning point indicators in one picture:

Graph #1: Household Debt relative to Disposable Personal Income, 1952-2015

Approximate dates of the turning points:

1 = 1964Q4 ... 2 = 1984Q3 ... 3 = 1987Q2 ... 4 = 2001Q1 ... 5 = 2007Q4

Before turning point 1:	rapid increase
From turning point 1 to 2:	not much change at all
From turning point 2 to 3:	very rapid increase, faster than the years before #1
From turning point 3 to 4:	gradual increase (slower than the years before #1)
From turning point 4 to 5:	very rapid increase, like 2 to 3, for a longer period
After turning point 5:	decline, at first very rapid but then gradual.

So -- what does all this mean? Can you see from the graph whether "rising debt is something we should be concerned about, or just the result of growing incomes"?

I can't.

From what we know about the economy, we can look at the graph and say wow, the very rapid, sustained increase from point 4 to 5 was something we should have been concerned about.

Funny thing, though. From what I know about the economy, I look at the graph and say we should have been concerned about debt from 4 to 5... and from 3 to 4... and from 2 to 3... and from the start to 1, too. The way I look at it, debt was going up all the while.

But, you say, but debt obviously was not going up from point 1 to point 2. I think that's what you say. And then you might add: so the debt problem could not have started before turning point 2.

Many people think that. It is true that the plotted line on Graph #1 runs pretty flat from turning point 1 to 2. But that does not mean debt wasn't going up. All it means is that debt wasn't going up relative to disposable personal income. It means debt and DPI were going up about the same, from point 1 to point 2. In the other periods, 2 to 3 and 3 to 4 and 4 to 5 (and also before point 1) debt was going up faster than DPI. That's what makes the line go up, debt going up faster than DPI.

Oh, and after turning point 5, debt is going up more slowly than DPI. That's what makes the line go down. Yeah. And the line going down is how we know rising debt is something we should have been concerned about before the peak at turning point 5.

Sadly, you don't know it's going to be a peak until after the line starts going down. And then ... well, by then it's too late.


What about that flat spot between turning points 1 and 2? I say debt and income were growing at the same rate, give or take. To see if I'm right we can separate debt from income and look at them separately.

Graph #2 shows year-on-year increase in household debt:

Graph #2: Growth Rate of Household Debt (blue)

The numbers are all over the place, of course. But you can see the numbers are lower in the 1960s than the 1950s, and seem to drift downward till 1970. Then there are three large jumps, two in the 1970s and one in the 1980s.

Knowing that much, we can say that household debt growth in the 1960s was mostly between 5% and 10%, with an average about halfway between. Then in the 1970s the plot line races up and down, but seems fairly well centered on the line that indicates 10% growth, up from 7.5% or so the decade before.

The next graph, Graph #3, shows year-on-year increase in disposable personal income, in red. Again the line is all over the place. But it looks to be centered on the 5% line in the 1950s and the early 1960s. Then it runs a little higher, centered maybe a little above the 7.5% line for most of the 1960s and early 1970s. Then it runs higher yet, averaging somewhere close to the 10% line for most of the 1970s and early 1980s.

Graph #3: Growth Rate of Disposable Personal Income (red)

Despite all the variations visible on the two graphs, for about ten years beginning in the early 1960s the red and blue lines both average out at about 7.5% growth or a little higher. And for about ten years beginning in the early 1970s both lines average out around a 10% growth rate. For that 20-year period, the growth rate of household debt and the growth rate of disposable personal income run neck and neck.

That's why we see a flat spot for that 20-year period on Graph #1.


There is another line on Graph #3, a very faint gray line. That line also shows disposable personal income, like the red line, but with inflation stripped out of the numbers. You can see that before the mid-1960s the red and gray follow the same pattern and run close together. Then the two lines separate for about 20 years; during those years there was rather a lot of inflation. Then after the early 1980s the two lines come together again.

As you can see, the inflation of that 20-year period pushed disposable personal income up. This is the reason debt and income grew at comparable rates in those years. It explains why the debt-to-income ratio on Graph #1 runs flat in those years.

If not for that inflation, there would be no flat spot on Graph #1. The graph would show increase from inception to crisis. At what point in that counterfactual would you say rising debt becomes a concern?

Rising debt is always a concern, because policymakers don't yet know enough stop it before it brings the economy to ruin.

Mine of 14 December 2015

Simon Wren-Lewis's of 13 December -- "Using economic statistics in an impartial and informed way" -- is his draft submission to the BBC Trust (whatever that is) on the topic of using economic statistics in an impartial and informed way. Without going on a limb, I think I can safely say Simon is in favor of using economic statistics in an impartial and informed way.

Me, too.

I like his post. Mostly I like it because, in the opening paragraphs, when Simon needs an example he uses debt. And not only government debt, but also personal debt. That's good. That's progress. Not only government debt.

I do like the post also for Simon's position on his topic. Here, here's his opening:

I would just like to make a few specific points about the use of economic and financial data. This data should be presented in a way that informs the public, rather than in a way that is meaningless to everyone except experts, or worse still in a way that fosters some political position.

Oh.

Yeah.

Of course. But is there anyone who would say the opposite? Anyone who would say outright that it's bad to inform the public? Is there any rational (cough) person who would openly admit to using economic data to mislead people for political gain? I don't think so. That's the sort of thing people only say about other people.

I suppose it doesn't hurt once in a while to say out loud the thing that Simon Wren-Lewis is saying. But to my ear, what Simon says goes without saying. I want to talk about something else. I want to talk about debt and context. Simon says:

... I have seen a well known BBC financial journalist quote, without qualification, numbers for how much UK government debt is increasing every day, in a manner that is clearly designed to suggest that this is a very serious problem. But numbers like this are meaningless on their own...

Mistakes like this could be avoided to a large extent by applying some normalisation. To return to the debt example, numbers for debt and deficits should routinely be given as shares of GDP... An alternative normalisation that would make such figures more meaningful would be to divide them by total household income. Figures for aggregate personal debt should always be normalised with respect to household income, because only then can we really see if rising debt is something we should be concerned about, or just the result of growing incomes

Now we're talking.

Here, look at this:

numbers for debt and deficits should routinely be given as shares of GDP

and this:

An alternative normalisation that would make such figures more meaningful would be to divide them by total household income.

Simon wants to see the numbers in context. (So do I.) He explains:

Figures for aggregate personal debt should always be normalised with respect to household income, because only then can we really see if rising debt is something we should be concerned about, or just the result of growing incomes

He wants to see debt in relation to income -- government debt in relation to GDP, personal debt in relation to personal income.

But Simon says not everything should be put in the context of GDP. GDP, for example. Simon would put GDP in the context of population. "Per capita growth is much more relevant for the public," Simon says, "because it is closer to how fast average incomes are growing."

I agree with Simon when he says context is important. I agree when he says GDP (or income) is not always the best context. But for debt, oddly, Simon would "routinely" use GDP or income as the context. I would not.

"Routinely" -- That mean something like "without having to stop and think about it". That's a problem. Using GDP for context without ever stopping to think about it is just as bad as providing no context at all: just as thoughtless, and possibly just as wrong.

But you cannot know if it's just as wrong, unless you stop and think about it.


Sometimes an employer will borrow money in order to meet payroll. When the employer hands out the paychecks he is creating income. Do you think this newly created income provides a good "context" for debt? I don't. It's new debt that created the income. Use income as a context for debt and you are looking at how much of the debt was used to create new income, and how much was not. Not very useful.

If you stop the economy and look at it, all the debt is still there, but no income at all. Income is a terrible context for debt. I prefer to compare debt to the quantity of money available for paying the bills. The money doesn't disappear when you stop the economy. The income disappears, but not the money.

If you stop the economy and look at it, there is no income because the economy is stopped: There is no flow. But there is money. I still have the greenbacks in my pocket. You still have the money that you would have spent if we didn't stop the economy. That money is still there, even though there is no additional income being generated. We can add up all that money, our spending-money, and call it M1 or something.

We can take debt and look at it in comparison to the quantity of spending-money. Look at debt in comparison to the amount of money we have that we can use to make payments against debt. Use spending-money as the context for debt.

When you start the economy up again, and look at it, income is being generated again and now you might say income provides a good context for debt. But who can say? Maybe the economy will start up and run really fast, and generate a lot of income. Or maybe the economy will start up and run slowly, like our economy after the 2009 recession, and then not much income is generated. Who can say?

If the economy generates a lot of income, debt in the context of income looks smaller. If the economy fails to generates a lot of income, debt in the context of income doesn't look smaller. These are illusions arising from the use of income as a context for debt. These illusions do not arise when spending-money is used as the context for debt.

But you would have to stop and think about it.

No wonder she's smiling

An Exercise

Real Gross Domestic Product = RGDP

Real Gross Domestic Product per Capita = RGDP/Population

RGDP divided by RGDP/Population = Population


Put POP, FRED's version of population on a graph along with Real Gross Domestic Product divided by Real Gross Domestic Product per Capita. If the two come out the same, POP is a good data series to use for "per capita" calculations.

Graph #1

Yup.


Sample usage:

Graph #2: Potential RGDP per Capita

Immigration and economic vigor

At the "Five Short Blasts" Forum: November Employment Report Looks Strong – in the “New Normal” Economy:

... To hear economists tell it, the economy is doing great. Even the Federal Reserve has begun to sip the Kool-Aid, licking its chops at the prospect of jacking up interest rates next month.

... Our “new normal” high is 2%, or about six million workers, lower than it was before the recession...

Nevertheless, the Federal Reserve sees this as a good time to shoot a hole in the boat. I think it’ll be sorry.

Pretty interesting stuff. Well written. Shows graphs. Looks at the numbers (like "Per Capita Employment") his own way. Pretty interesting stuff.

The guy's name is Pete Murphy.

//

Murphy's post links to an older one: 315,000 More Workers Vanish in November (from back in 2011):

If President Obama has been smart enough to restrain the growth in the population through cuts in immigration, he’d now be talking about a real, significant drop in unemployment – one that actually feels like an improved economy – instead of one that’s been trumped up by proclaiming that millions have simply given up looking for work.

I don't think I ever looked at immigration. Pete got me interested.

The Migration Policy Institute has a graph showing the "annual number of U.S. legal permanent residents" for the 1820-2013 period. Plus, you can download the numbers. So, I did. Then I went to FRED looking for population numbers, for comparison.

Graph #1: Annual Number of Legal U.S. Residents as a Percent of
Total Population: All Ages including Armed Forces Overseas
(Damn! I forgot to clear the subtitle line.)

General uptrend since 1952, and an unusual spike around 1991. Dunno the explanation for the spike. Same trend (and same spike) appear at Migration Policy Institute.

Graph #1 starts out showing around 0.1% of population as immigrants. One person in a thousand. In the late years it shows 0.3 or 0.4% -- three or four in a thousand people. Three or four times the starting number, but still not a lot.

Dunno if immigrants still count as immigrants after they get citizenship, or if they come out of the count. That would affect the interpretation of the graph.

Dunno what Murphy has in mind when he says Obama should have put restraints on immigration. Looks to me like the immigrant population was falling all through the Obama years.

//

Pete Murphy's sidebar offers his proposed 28th Amendment to the Constitution of the United States. The text of it says

The United States shall not be a member to any international organization that does not recognize the United States’ fundamental right to manage international trade in its best interest.

Sounds good to me. The same proposed amendment says

The United States shall not maintain a trade deficit with the rest of the world. The Congress shall enact trade policy utilizing import quotas and tariffs as necessary ...

I have to reserve judgement on that.

I like the site because Murphy has developed his own theory -- a "theory of population density-induced decline in per capita consumption", as he puts it. I find it interesting (in the sense that I have to think about it before I know what I think about it).

On his “Free” Trade? page, Murphy lays out an overview of his theory:

... as population density rises beyond some optimum level, per capita consumption begins to decline. This occurs because, as people are forced to crowd together and conserve space, it becomes ever more impractical to own many products. Falling per capita consumption, in the face of rising productivity (per capita output, which always rises), inevitably yields rising unemployment and poverty.

He's trying to explain the decline in consumption, or the sluggishness of aggregate demand. He's got his eye on the target, and his explanation is far more interesting than Scott Sumner's. (The interesting thing about Sumner is not his solution -- print more money -- but that he manages to get away with saying it while calling himself conservative.)

My kneejerk is that the lethargy in consumption and/or aggregate demand is due to the cost of accumulated private debt, combined with the widespread desire to reduce rather than expand that debt. That seems a much stronger argument to me than Murphy's notion that overcrowding makes owning things impractical.

I've not yet read enough of Pete Murphy to pass judgement on his work. But he does leave me a bit confused.

Inflation adjustment of debt, again

Happy Thanksgiving!

I was looking for something... interest on government debt us... and came upon the nice, professional-looking site of Daniel Amerman, CFA. Pretty graphs, each on black background. One that really stands out is his interest rate graph, yellow on black. This is beautiful stuff.

Some interesting graphs, too -- interesting for what they show rather than how they show it. His first graph, titled "30 Year Earnings on $10,000 Investment", shows earnings for 1% interest versus 6% interest. The difference is staggering.

The graph that got me writing was Amerman's picture of the "US Federal Debt, 1947-1970 (Fiscal Years)". This graph:

Graph #1. Source: Daniel Amerman

It shows the Federal debt (top edge of the red area) and the Federal debt adjusted for inflation (bottom edge of the red area). As it says on the graph, the red area shows the "reduction in real debt" due to inflation.

So in 1970, for example, to pay back about $148 borrowed dollars it would take only about $85.

Well no, not really. It would still take $148 dollars to pay back $148 borrowed dollars in 1970. But $148 would only be worth about $85. I think that's Daniel Amerman's point. It's another way of saying "inflation erodes debt".

In 1947 it took $100 to pay off $100 borrowed ... in 1952 about $84 to pay off $100 borrowed ... in 1966 it took about $88 to pay off $125 borrowed. Yeah, yes and no. Interest aside, it always takes a dollar to pay back a dollar. But if there's inflation, the dollar you're paying back is worth less than the dollar you borrowed in the first place.

So, in 1952, the $100 you paid back was worth about $84. In 1965 the $125 you paid back was worth about $88. And in 1970 the $148 you paid back was worth about $85. That's what the graph shows.

But it is not really right. It assumes you did all your borrowing in 1947, or that you only borrowed dollars that were worth what a dollar was worth in 1947. And of course that is not the case.

Daniel Amerman's graph shows the Federal debt (as a percent of the Federal debt in 1947) and shows the value of that debt in inflation-adjusted dollars. But the inflation adjustment is based on starting in 1947. The graph assumes that all the dollars the Federal government borrowed were 1947 dollars.

Here, I checked my evaluation of the graph:

I downloaded annual data from FRED: GDP Deflator in the second column, and gross Federal debt in the fourth column. In the fifth column (Column E) I calculated "loss of value since 1947" numbers. Not loss of value. Retained value. If you borrowed $100 in 1947 and paid it back in 1952, the dollar was worth a little less, so you only paid back about $86.07 of the purchasing power that was in the $100 you borrowed in 1947. $86.07 is the retained value, what $100 from 1947 was worth in 1952.

See row 18, and column E. I selected Cell E18 and clicked a key to edit the cell, so you can see the calculation I put into that cell:

=100*B13/B18

In that formula, the "B13" is blue -- and cell B13 has a blue box around it to make it easy to see what number is being used in the calculation. (Similarly, the text "B18" is red, and cell B18 has a red box around it.) The spreadsheet program puts those colors there automatically to make things easier to see when you're editing a cell.

I didn't actually want to edit the cell. I just wanted to show you the calculation I used. Further down in Column E (on row 31) there is the number 86 point something (for the year 1965) ... and (on row 36) there is the number 83 point something (for the year 1970). There was a number like that in the cell where we see the calculation, cell E18, but we can't see the number because that cell is in "edit" mode.

Before I activated edit mode, I copied the value from that cell up to the top of column E. On row 1, cells D and E you can read my note: Cell E18 = 86 point something.

The calculation in cell E31 (for 1965) is

=125*B13/B31

The calculation in cell E36 (for 1970) is

=148*B13/B36

Oh, and the calculation in cell E13 (for 1947) is

=100*B13/B13

In each case I took the amount paid back, multiplied by the price index for 1947 (the assumed year-of-borrowing) and divided by the price index for the year-of-payback. Each calculation figures the value lost retained since 1947.

To summarize, the numbers I calculated were $86.07 (for 1952), $86.14 (for 1965), and $83.70 (for 1970). The numbers I got from Daniel Amerman's graph were $84 (for 1952), $88 (for 1965), and $85 for 1970. In each case my calculated number is off a little, compared to my estimate from the graph, but in all cases it is close. (The graph at FRED is also a little off from Amerman's. It's also off from what I expected: I indexed the FRED graph series to make it 100 in 1947, like Amerman's, but both lines came out below 100 for some reason. Close enough for government work, I guess.)

Close enough. I'm satisfied that what I said above is accurate: The assumption underlying Daniel Amerman's graph is that all the dollars borrowed by the Federal government were 1947 dollars.

But in fact not every dollar of Federal debt was borrowed in 1947.

Therefore, there is a error in the graph.


It's not only Dan Amerman's graph. It's almost every graph that shows the inflation adjustment of debt. You can't take a lump sum number like debt -- a number accumulated over many years in an inflationary economy where the value of the dollar changes over time -- and calculate the "real" value the same way you would figure "real" GDP. The calculation doesn't work for debt, because debt is accumulated over many years, and the value of the dollar changes over time.

To calculate the "real" or "inflation adjusted" value of debt, you have to adjust each year's addition to debt separately, using the price index for each year in turn.


Daniel Amerman's graph does provide some useful information. It shows that if we paid off Federal debt today, we'd be paying dollars that are worth less than the dollars we borrowed. But of course we're not going to pay off the Federal debt today. So I don't know how useful his graph is. Except it's useful to me, because it helps me show that the method commonly used to figure "real debt" is incorrect.

Frameworks

In a recent post Arnold Kling notes that both Scott Sumner and Tyler Cowen have offered "frameworks" or outlines of their macroeconomic thinking. In that post Kling presents a framework of his own. You know I had to take a look at all three.


Arnold Kling -- My Macro Framework:

... How do we get into messes? To some extent, each unhappy economy is unhappy in its own way. But some elements that one tends to find include Minsky-Kindleberger manias and crashes, sudden changes in credit conditions, sharp movements in important relative prices (oil, home prices), and permanent shifts in the skill structure of work.

It is a minor point. But if the question is How do we get into messes? then "sudden changes in credit conditions" is not the right answer. The sudden change in credit conditions *IS* the mess. What gets us into the mess is the long, slow, gradual change in credit conditions.

We start with a small accumulation of private sector debt and reach climax with a vast and unsupportable accumulation of private sector debt. This slow change is how we get into the mess. The moment that everyone suddenly realizes debt is excessive -- the moment of the sudden change in credit conditions -- in that moment we are already in serious trouble.


Sumner -- Is it time to blow up the New Keynesian model?

In the short run, employment fluctuations are driven by variations in the NGDP/Wage ratio.

Both NGDP and wages are nominal quantities. If you think of wages as a measure of the price level, you'll see that the NGDP/Wage ratio gives you a measure of RGDP. If this is correct, Sumner is only telling us that

In the short run, employment fluctuations are driven by variations in RGDP.

or maybe that

In the short run, variations in RGDP are driven by employment fluctuations.

And now perhaps it is obvious that Sumner is simply restating Okun's law.

That's okay. Maybe Scott Sumner secretly prefers old Keynesian to new Keynesian.


Tyler Cowen -- My macroeconomic framework, circa 2015

... stimulus to be effective needs to be applied very early in the ... recession.

Yes, that's correct. I called it urgency.

Tyler Cowen again:

Given that weak AD is only one of the problems in a bad downturn, and that confidence, risk, and supply side problems matter too, the best question to ask about fiscal policy is how well the money is being spent. The “jack up AD no matter” approach is, in the final political equilibrium, not doing good fiscal policy any favors.

Sumner's framework is a pretty well-focused piece of writing. So is Arnold Kling's. Cowen's strikes me as a jumble of semi-important points emerging from spontaneous free association. His "Given that weak AD" paragraph is a perfect example. He's got a whole list of things that matter, but he has not prioritized his list. He leaves it a mess, and from it draws the conclusion that we should ask a bad question about fiscal policy.

That question arose long ago in response to Keynes, who said that if lawmakers are prevented (by their misunderstanding of the economy) from spending on worthwhile objectives when fiscal stimulus is needed, then even spending foolishly would be better than failing to provide stimulus.

The question only arises if you misunderstand the point Keynes was making.


Dunno if I have a "framework" but I'll give it a go.

1. The economy is transaction. Exchange. Trade. Transaction. Everything that happens in the economy can be seen in monetary balances.

2. Don't worry about the real economy. The real economy takes care of itself. Look at the birds of the air; they do not sow or reap or store away in barns, but they get by.

3. Worry about monetary balances. When these get out of whack they do great harm to the real economy.

4. Cost is always a problem.

5. Don't make economics more complicated than it has to be.

What would the new minimum wage be?

From Marx & MMT, Part 1 at heteconomist:

Labor of an ordinary or basic kind is called ‘simple labor’. Skilled labor is called ‘complex labor’ and is treated as a multiple of simple labor. The easiest way to make this reduction is to compare the wages (defined to include non-wage pecuniary benefits) of different types of labor. If the average wage is three times the minimum wage, society is behaving as if an hour of average labor is worth three hours of simple labor. In this way, all labor can be reduced to simple labor. The reduction is social, made by society itself, rather than necessarily natural or technical.

I'd rather think in terms of the average wage, not the minimum wage and multiples of the minimum wage. Much simpler. Beside the point.

I thought the ratio was an interesting idea -- the average wage relative to the minimum wage. So I went to FRED looking for it. To get a long-term view I ended up using average hourly earnings for production and non-supervisory employees in manufacturing.

Manufacturing has been in decline in the U.S. So any uptrend on the graph is probably muted because of my choice of data. And it looks like the average wage would be higher in general if supervisors' wages were added in. So, what Graph #1 shows is likely lower and flatter than we'd see if better numbers were used. (Oh, well.)

Graph #1: The Average Hourly Wage as a Multiple of the Minimum Wage

We see a sawtooth pattern because the minimum wage changes only occasionally. When the minimum wage is raised, the average wage is suddenly a smaller multiple of it, so the blue line drops sharply. Then the minimum wage stays the same while the average wage gradually climbs, and the blue line goes up for a while. This explains the sawtooth pattern.

The graph shows that from 1950 to 1970 the average wage was roughly twice the minimum wage -- in the neighborhood of 2.0 on the vertical axis. Then in the 1970s the average wage was a little higher, around 2.3 times the minimum wage. And since the mid-1980s, the average wage has been higher yet -- near 3 times the minimum.

Okay. So during the "Golden Age" the average wage was about 2 times the minimum wage, and during the "Great Moderation" the average wage was about 3 times the minimum wage. Call it 2.8 times the minimum wage. Just about where it is now.

//

I took the minimum wage, the average wage (the same one as in Graph #1) and the Consumer Price Index and put 'em all on a graph together. I "indexed" them so they're all equal in January 1952. Each has the value 100 in January 1952. Why January 1952? Because at that time the average wage was almost exactly two times the minimum wage. I set them equal in order to see which went up faster and which went up slower.

Graph #2: A Comparison of Increase -- the Average Wage, the Minimum Wage, and the CPI

The blue line went up faster. That's the average wage. It went up faster than the red line (the minimum wage) since around 1970, definitely.

The two government statistics -- the minimum wage and the CPI -- follow each other pretty closely, and both of them are well below the average wage since the 1980s. Among other things, this tells me that yeah, the CPI understates inflation.

(Remember, the blue line excludes supervisors' wages and considers only the wages of the manufacturing sector, not a strong growth sector in the U.S. economy. So the blue line understates the average wage. And the green line is even less. The minimum wage runs with the understated inflation number.)

//

We know from Graph #1 that the average wage went from two times the minimum wage to 2.8 times the minimum wage.

We know from Graph #2 that the average wage went up faster than the minimum wage.

Suppose we wanted to raise the minimum wage so the average was only 2 times the minimum again, like in the 1950s and '60s. What would the new minimum wage be?

Well, in September 2015 the minimum wage was $7.25. The average wage was $20.06. To make the average wage twice the minimum wage, the minimum wage would have to go up to $10.03.

$10.03 of Graph #2 would bring the red line straight up to where it just touches the blue line. Then the red line would run flat again until the next increase (if ever). So probably we would want to make the red line go a little higher than the blue. We might want to raise the minimum wage to $12 or so.

Maybe that's where the $12 number comes from.

//

Google turns up calls for a $15 minimum wage. I had to go looking for $12. First thing that turned up was Tim Worstall's A $12 Minimum Wage Would Cost 777,000 Jobs And Wouldn't Reduce Poverty Much Either.

Worstall says a $12 minimum wage "would cost some three quarters of a million jobs".

I was thinking...

$12 puts the minimum wage back where it once was, running neck-and neck with half the average wage. (Yeah, yeah, the average wage has been lagging too; maybe that's where the call for a $15 minimum comes from. But that's another story.)

$12 puts the minimum wage back where it was during the "Golden Age" of the 1950s and '60s. But Tim Worst all says going back to the Golden Age standard would cost us jobs. I think he's full of opinion.

Graph #3: The Minimum Wage, Neck-and-Neck with Half the Average Wage Until 1970

"Where has the vanishing labor force gone?"

So where have they gone? How are they supporting themselves? Well, the above linked study published by Princeton last week gives us an inkling about what’s become of them. They’re living in despair. And they’re dying.

Recommended reading: Where has the vanishing labor force gone? Now we have a clue. at "Five Short Blasts" Forum.

Williamson versus the world

The World:

The Queen of England was standing in a hall at the London School of Economics looking a little perplexed. The date was Novem­ber 4, 2008, and she had arrived to open a new building on campus...

The event was supposed to be a celebration of academic achievement, but the timing was poignant. Two months earlier, the financial crisis had erupted in London and many other parts of the West, leaving hordes of economists and pundits scurrying to provide analysis. As the Queen toured the build­ing, Luis Garicano, one highly regarded economist, pre­sented her with some charts that purported to show what was going on in finance.

The Queen peered at the brightly colored lines. “It’s awful!” she declared, in her clipped, upper-­class vowels. “Why did nobody see the crisis coming?”

- Gillian Tett in The Atlantic

The Queen asked the question everyone was asking. And hordes of economists were trying to figure out what happened. Meanwhile, Steve Keen pointed to two studies that between them found a total of 16 economists who saw the crisis coming:

A majority of the 16 individuals identified in Bezemer (2009) and (Fullbrook (2010)) as having anticipated the Global Financial Crisis followed non-mainstream approaches ...

- Steve Keen

And not even Alan Greenspan anticipated the crisis, though Congress thought he ought to have:

Committee Chairman Henry Waxman, (California Democrat) said to those present: The reasons why we set up your agencies and gave you budget authority to hire people is so you can see problems developing before they become a crisis. To say you just didn't see it, that just doesn't satisfy me. Finally, Greenspan told the lawmakers that regulators could not predict the future ...

- Nabil Abu el Ata, Maurice J. Perks

 

Stephen Williamson, however, sees things differently. He sees not only "the" future, but all possible futures -- and he knows what is likely, and what is not:

In principle, the current state of the economy determines the likelihood of all potential future states of the economy.

- Stephen Williamson

Remarkable.

Antonio Fatas and the Chain of Causality

From GDP growth is not exogenous by Antonio Fatas:

Ken Rogoff in the Financial Times argues that the world economy is suffering from a debt hangover rather than deficient demand. The argument and the evidence are partly there: financial crises tend to be more persistent. However, there is still an open question whether this is the fundamental reason why growth has been so anemic and whether other potential reasons (deficient demand, secular stagnation,…) matter as much or even more.

The Ken Rogoff opening is an attention-grabber. I'm sure you remember Reinhart and Rogoff and the 90% threshold -- when public debt reaches 90% of GDP, they said, bad things happen to economic growth. You remember.

But I remember something else Rogoff said, after that, in Debt supercycle, not secular stagnation at VOX:

I will argue that the financial crisis/debt supercycle view provides a much more accurate and useful framework for understanding what has transpired and what is likely to come next...

The evidence in favour of the debt supercycle view ... includes the magnitude of the housing boom and bust, the huge leverage that accompanied the bubble, the behaviour of equity prices before and after the Crisis, and certainly the fact that rises in unemployment were far more persistent than after an ordinary recession that is not accompanied by a systemic financial crisis. Even the dramatic rises in public debt that occurred after the Crisis are quite characteristic.

See it? Even the dramatic increases in public debt, he says. This time Rogoff is clearly not saying the big increases in public debt are the cause of our troubles. Those increases "occurred after the Crisis", he says. Consequence, he says, not cause.


The Rogoff article linked by Antonio Fatas is dated 9 October 2015. From the opening:

What is the right diagnosis of the ailing global economy? ...

Some argue that we are living in a world of deficient demand, doomed to decades of secular stagnation. Maybe. But another possibility is that the global economy is in the later stages of a debt “super cycle”, crushed under a burden accumulated over years of lax regulation and financial excess.

I had to look. Fatas says Rogoff "argues that the world economy is suffering from a debt hangover rather than deficient demand." I had to check that. When I read Fatas, I thought he might be misinterpreting Rogoff. He's not. He's right. Rogoff sees secular stagnation as one possibility, and crushing debt as "another possibility".

Rogoff sees the excessive debt explanation as an alternative to the deficient demand explanation.

That's just plain silly. Excessive debt is not an alternative to the "deficient demand" explanation. Excessive debt is the cause of deficient demand. First, the growing cost of growing debt consumes a growing portion of income. So demand atrophies gradually at first. Then, people suddenly come to think of their debt as excessive, and they suddenly cut their borrowing and spending. Demand falls suddenly -- economists call that a "shock" -- and we have "deficient demand".


Let me start again. Antonio Fatas:

Ken Rogoff in the Financial Times argues that the world economy is suffering from a debt hangover rather than deficient demand... However, there is still an open question whether this [debt hangover] is the fundamental reason why growth has been so anemic and whether other potential reasons (deficient demand, secular stagnation,…) matter as much or even more.

No. It's not an open question. Excessive debt is the cause of deficient demand. Secular stagnation is the result.

Thoughtless

Brad DeLong:

Indeed, back in 2000 it was Ben Bernanke who had written that central banks with sufficient will and drive could always, in the medium-run at least, restore full prosperity by themselves via quantitative easing. Simply print money and buy financial assets. Do so on a large-enough scale. People would expect that not all of the quantitative easing would be unwound. Thus people would have an incentive to use the extra money that had been printed to step up their spending.

The goal, see, was to get people to "step up their spending". But, as DeLong says, the result "has been unexpectedly disappointing".

I think that's why central banks these days are thinking about going cashless. It's the next logical step in the plan to get people to step up their spending.

The trouble is, it's not a good plan. It's a major change to life as we know it -- to life as we've known it for millennia, I guess, since cash money was first invented.

It's a major change, tacked on as an afterthought to a plan that didn't work, the plan to get us to step up our spending. It's an afterthought tacked on to a plan that didn't work.

If we're going to abandon cash, shouldn't we put a little more thought into it than that?

Say "OOF"

Here's what I'm looking at:

Part of this page as of 31 October at six in the morning, my time.

I'm there because of the post. Dillow points out "the general public's lack of understanding of economics" and says: "people underestimate the tendency of emergent processes to produce benign outcomes".

Snort. Maybe people lowball the economy's tendency to produce benign outcomes because the outcomes are generally not benign.

But that's not what got me writing this morning. What got me writing was that I read those two links in his sidebar, the ones in red boxes.

The Search for Yield

"Search for Yield" links to Rational and Behavioural Drivers of Financial Markets: the case of ‘search for yield’ by Silvia Pepino:

The ‘search for yield’ (or ‘reach for yield’) observed in financial markets in recent years is a striking manifestation of the interaction of rational and behavioural factors. During an extended period of low interest rates and volatility, market participants have displayed a tendency to seek higher returns by investing in securities that carry higher credit, liquidity or duration risk.

... financial market practitioners and policy makers generally refer to ‘search for yield’ as the tendency of investors to take on higher risk in exchange for higher expected returns when interest rates are low...

In recent years, against the backdrop of very low interest rates and quantitative easing, a tendency has developed among investors to accept higher duration, credit and liquidity risk in order to boost returns.

... a tendency to ‘search for yield’ in financial markets can become a reason for concern, particularly when it is perceived to become excessive and lead to under-pricing of risk.

The article is about rational and behavioral "drivers" of the search for yield. I'm ignoring drivers. I'm focusing on the tendency of investors to take on higher risk in exchange for higher expected returns when interest rates are low.

Okay.


Everyday stagnation

"Everyday stagnation" links to Chris Dillow's post at Investor's Chronicle. (You may have to register to read it.)

One of the few drawbacks of working from home is that one is bombarded with annoying phone calls from time-wasters...

All those cold callers give us a daily - well, hourly - reminder that the economy isn't dynamic enough to create sufficient productive and rewarding jobs. In other words, we are in an era of secular stagnation. This phrase has many meanings; it refers to the combination of slow productivity growth, weak investment and low innovation that have given us negative real interest rates...

Stagnation, though, hasn't only given us poor returns on cash. It has also depressed equity returns.

A recent paper by Gianluca Benigno at the LSE and Luca Fornaro at Barcelona's University of Pompeu Fabra points out that economies can fall in a stagnation trap. If people expect low growth they won't invest or innovate and this will cause low profits for other companies, thus exacerbating disincentives to invest. In this way, pessimism can be self-fulfilling.

The problem is that such pessimism might be justified.

One reason for this is that profit rates have fallen. The economics blogger Michael Roberts estimates that returns on capital in G20 countries have steadily fallen since the early 1970s.

Production is the source of profits, the source of "yield". The yield to financial markets pulls yield away from productive markets.

Growing financial profits reduce productive sector profits. Falling profits in the productive sector reduce growth, productivity, investment, and innovation. This leads to lower interest rates and depressed equity returns.

Growing financial profits undermine the source of profits. Let finance gain at the expense of the productive sector, and you set the stage for reduced yield in financial markets.

The problem is not "pessimism". The problem is "OOF": Onerous overgrown finance.

The Neutral Zone

As I write this, it is 9:32 AM on Sunday morning. Would have been 10:32, but we sprung back while I was sleeping. Scheduled for 4 AM Monday I have "Are we tight yet?" where I review an article about the Fed's problem in finding the neutral rate of interest. Therein I say:

If we define "the neutral rate" as the article does:

"the borrowing cost -- adjusted for inflation -- that keeps the economy at full employment with stable prices"

then I'm not even sure the neutral rate exists. Since the crisis, I mean.

At Marginal Revolution: What’s the natural rate of interest? Tyler Cowen writes:

Whether a given rate of interest both maintains full employment and stable inflation depends on the rate of productivity growth, for one thing. It can be that no single rate of interest can perform both functions.

Pretty much what I said.

I like the whole Marginal Revolution article. Lots of links that look most interesting. And a very good quote from Milton Friedman (of all people!).

"Are we tight yet?"

RockyMcNuts at Reddit links to Are We Tight Yet? The Fed's Problem in Finding the Neutral Rate at Bloomberg Business. I like it.

When the topic is cast as We should raise interest rates immediately! or No, we shouldn't! it seems to get a lot of attention. Cast as a discussion of the Fed's difficulty in deciding whether to raise interest rates, and when, it gets very little interest even after 14 hours on Reddit. 

That's part of the problem. Everybody already has an opinion. Everybody thinks they know the answer. Everyone is satisfied with their answer. (And yet, we disagree.)

What I liked about the Bloomberg article was that it focused on not knowing the answer. For me, that opens a door.


From the article:

“The one thing you know is that you don’t know,” said James Hamilton.... “People in the Federal Reserve and everywhere else are trying to figure out: What’s the permanent change, and what’s just the overhang from the episode we’ve been through?”

...

If the natural rate is well above the current near-zero rate, as Chair Janet Yellen and many of her colleagues suggest, then policy will still be accommodative well after the central bank begins to raise rates, encouraging further investment and hiring.

If the gap is smaller -- or if the natural rate has fallen so much that it’s at or under zero, as some suggest -- the early stages of tightening could restrain the U.S. economy more than Fed officials expect.

“There’s a lot of uncertainty about what the appropriate level is,” said Laura Rosner.... Such discord “is going to heighten the disagreement about what to do with rates.”

Even among economists, evidently, most of them think they know the answer. And, like the rest of us, they disagree with each other. This disagreement apparently leads to uncertainty at the policy level. The article says a new study "emphasized that a lack of conviction 'in turn creates uncertainty about the appropriate level of the short-term interest rate'." Or again:

There’s also disagreement about how the Fed should respond to the uncertainty surrounding the level of the natural rate.

By "how the Fed should respond" they mean "raising the benchmark rate sooner rather than later" or "the opposite." This gives the impression that the lack of consensus is the source of trouble -- that if economists could only manage to agree, then their answer (whatever that answer happened to be) would be the right answer, and the Fed would go with it.

It seems they are saying the neutral interest rate is determined by consensus opinion. I don't buy it.

I think it bizarre that a lack of consensus in the private sector could lead to uncertainty at the Fed. It is as if policy-makers think a policy is wrong if opinion-makers think it is wrong. This is bullshit. Given economic conditions at any point in time, there is one general direction that points to the best choice for policy. This is true, regardless of what anybody thinks.

That's what I think.

Trouble is, policy-makers don't know which is the right direction.


If we define "the neutral rate" as the article does:

"the borrowing cost -- adjusted for inflation -- that keeps the economy at full employment with stable prices"

then I'm not even sure the neutral rate exists. Since the crisis, I mean.

Maybe the loss of our ability to achieve "full employment with stable prices" is the permanent change that James Hamilton was wondering about. ("Permanent" here does not mean "from now till the end of time". It means long-lasting or highly persistent.)

Loss of our ability to achieve "full employment with stable prices" or, say, to achieve full employment, period. If that was the permanent change, then disagreement over the level of interest rates is pointless.

That would explain why the disagreement cannot be resolved: Because both sides are right when they say the other side is wrong. Both sides are wrong, because setting the level of interest rates can no longer get us to full employment. The focus on interest rates is the wrong focus. We need instead to ask why achieving full employment is no longer possible.

See what I'm getting at here? We need to re-think economics. We need to re-think premises. We need to do something smarter and more honest than redefining "full employment" to a higher number (again) or changing who we count as unemployed to get that number down. Again.

We need to re-think the premises. This has been said many times, in many ways, since the crisis. But nothing has changed. We still think we can get back to "full employment with stable prices" by fiddling with interest rates while Rome burns.

Spring Ahead... Fall Back

Labor Share and what?

Labor Share and Potential GDP

GDI: Point of interest

I took the highest "Shares of GDI" series for "Compensation of employees" and divided it by the highest "Shares of GDI" series for "Corporate profits". The resulting graph runs from 1929 to 2014 and it all stays between 0 and 20 except during the Great Depression, when it drops down around -180, then bounces back up.

I chopped off those early years to get a better look at the rest of it:

Graph #1

Oh...

This is employee compensation as a multiple of corporate profits. In the 1950s and early 1960s -- the "Golden Age" -- compensation ran low, at about five times the profit level. Then, during the "Great Inflation" compensation increased, relative to profits. In the 1980s, compensation ran high, at about eight times the profit level. Since the early 1990s, compensation declined relative to profits, and volatility has been greater.

Graph #2: Same as Graph #1, with Trend Lines Eyeballed In

Not what you expected, is it.

Employee compensation was low in the good years. It was high in the Reagan years.

Know what I think? I think there must be more to the story than compensation and profits.


I wanted to check my trend guesstimates, so I recreated the graph with a Hodrick-Prescott calculation:

Graph #3: Data from Graph #1, plus a Hodrick-Prescott Trend (ƛ=100)

Now, that's interesting. The red line looks like a sine curve. It suggests a repeating pattern. Now that's interesting.

GDI: Corporate profits

At FRED, 25 series come up in a search for shares of gdi.

Five series come up for shares of gdi: Corporate profits. These five:

Graph #1

The highest (most all-encompassing) of the five is: Corporate profits with inventory valuation and capital consumption adjustments, domestic industries.