"potential output varies with demand"

Vernengo:

I think that there is significant evidence
for the notion that
potential output varies with demand

What Vernengo said

If I was talking I'd be tripping over my tongue. But I'm writing -- writing things out of sequence, because I can't stop to organize my thoughts. I have discovered Matias Vernengo, discovered what fascinates him: Productivity and Demand.

Fascinates me, too. Matias Vernengo says

Technological determinism is widespread. The Solow model basically suggests that it is technological progress, measured incorrectly as Total Factor Productivity (TFP), that drives growth. The same is true of Schumpeterian models...

What is NOT discussed in most analyses of the technological determinism by conventional and more than a few heterodox authors is the role of demand in creating the conditions for technological change. In that case, technological change is not the cause of growth, but the result. As in Adam Smith's story, it is the extent of the market (demand) that limits the division of labor (productivity). In modern parlance the idea is known as the Kaldor-Verdoorn Law.

"Sure enough" Vernengo says, "a demand driven story has space for the sort of external supply-side effects that allow technology and innovations to thrive... [A] demand driven story does not imply that supply side factors are irrelevant, they are simply not the prime movers."

I think he's onto something. That paragraph about technological change got me going. Reminded me of Arnold J. Toynbee. Regarding the abandonment of the irrigation system in the Tigris-Euphrates Basin, Toynbee wrote: "This lapse in a matter of technique was in fact not the cause but the consequence of a decline in population and prosperity..." In other words, the lapse was due to a lack of demand.

Regarding the abandonment of Roman roads, Toynbee wrote:

When a civilization is in decline it sometimes happens that a particular technique, that has been both feasible and profitable during the growth-stage, now begins to encounter social obstacles and to yield diminishing economic returns; if it becomes patently unremunerative it may be deliberately abandoned...

An obvious case in point is the abandonment of the Roman roads in Western Europe....

Matias Vernengo says demand drives technology. Arnold J. Toynbee says the lack of demand drives the decline of technology. These are two expressions of one thought.

Progress.org: Interview with Mason Gaffney

From 2007, Interview With Mason Gaffney on Corruption of Economics. Excerpts:

The Progress Report – In your latest book, The Corruption of Economics, you seem to be exposing an amazingly deep and long-standing scandal around the study of economics within the American education system. Sum it up for us. How, why and by whom do you think the teaching of economics in America has been corrupted?

Mason Gaffney – Generically, it goes back thousands of years: every system that divides mankind into rentiers and proles requires a rationale. Those with leisure have time and resources to provide it: sometimes directly, but usually through hired guns.

The need became more acute in the USA during and after the Progressive Era, with its development of the secret ballot and direct democracy. Voters could no longer be bought or intimidated directly; they had to be brainwashed. The device used was to replace the older Classical Political Economy (Quesnay, Adam Smith, Ricardo, Mill, and Henry George) with “Neo-classical Economics,” which blurred all distinctions between producers and rentiers.

TPR – They were paid to keep quiet about the land question?

MG – No more than anyone else. They lived in a society dominated by landowners. Adam Smith spent his life on the payroll of the Duke of Buccleuch, as tutor for His Grace’s son. Landowners were so very secure, some of them could let their house intellectuals tweak their noses with radical ideas – probably found it entertaining. It was later, after universal manhood suffrage, that the landowners got nasty and conspiratorial and defensive...

TPR – Do you believe this purchasing of economic theory still going on today, and if so, what well-known economists do you suspect of being involved with it?

MG – It pervades the culture of the profession. Most members are looking for grants and promotions to put frosting on their cake. They call it, “Responding to the incentive structure,” giggle nervously, and shuffle the blame onto “the system.”
...
It’s partly a matter of coopting people by dangling money before them, and partly a matter of selecting and supporting those whose ideas are already more simpatico to the major grantors. It’s hard to tell the difference, so it’s hard to say who’s been corrupted, and who corrupted himself at an early age.

TPR – How can my readers find out if what you’re saying is really true? Name the most widely used economics textbooks in American universities right now and what they teach that is an obvious lie for the benefit of landed interests.

MG – I no longer use textbooks much...

Paul Samuelson, Robert Solow, Peter Mieszkowski, Theodore Schultz, and Edwin Mills, for example, casually pronounce that land rent is only 5% or so of total income, so a single land tax could not support government as we know it. They offer no support for this except to echo each other... They simply ignore the few careful studies of the matter, as by Michael Hudson, Allen Manvel, myself, and Steven Cord, that show much higher figures.

TPR – How do you like our chances, Professor? Do you think Earth is going to be a loser planet or will the good guys somehow snatch victory from the jaws of defeat?

MG – A bit of each. Keep hassling, and things will be a bit better than if you gave up.

Again, I left a lot out.

Mason Gaffney: The Canal Boom

Google led me to The U.S. Canal Boom and Bust, 1820-1842, notes by Mason Gaffney from May, 1993 (updated 2009).

The Canal Boom, which crested in 1836-37, was one of several in U.S. history, forming roughly an 18-year cycle...

The slump, when it came, was synchronized nationwide; the ensuing slump and crash even more so. Indeed, the cycle was worldwide, although the data included herein is only for the U.S. After the manic peak of 1836, depression was communicated everywhere through some universal medium. The synchronization was remarkable, considering this was before even the telegraph.

This synchronizing medium was the capital market, which turns booms on and off by advancing or denying funds. After 1836, momentum carried some works forward, regardless of crashing demand and tight funds; by 1842 most building had ground to a halt.

Following the trough of 1842, production and employment slowly picked up new steam. Railroads were the new magic, aided along by Federal land grants after 1850. Before long it all built up to a new peak and crash, in 1857.

I left a lot out.

The spice of life

Maynard writes

... Nevertheless, circumstances can develop in which even a large increase in the quantity of money may exert a comparatively small influence on the rate of interest. For a large increase in the quantity of money may cause so much uncertainty about the future that liquidity-preferences due to the precautionary motive may be strengthened; whilst opinion about the future of the rate of interest may be so unanimous that a small change in present rates may cause a mass movement into cash.

It is interesting that the stability of the system and its sensitiveness to changes in the quantity of money should be so dependent on the existence of a variety of opinion about what is uncertain. Best of all that we should know the future. But if not, then, if we are to control the activity of the economic system by changing the quantity of money, it is important that opinions should differ.

Phases of the Business Cycle

Something I found while looking through my old notes on the Schumpeter essay in Readings in Business Cycle Theory, from a file I wrote (or last edited) back in 1996:

Schumpeter (writing in 1935) described a cycle in four phases. We speak today of four phases as well, but they are not the same. Today we speak of a period of growth, a peak, a period of recession, and a trough (pronounced to rhyme with "cow") or low point. Schumpeter, by way of contrast, emphasized the importance of the smoothed trend line about which the cycle varied. He described a period of prosperity followed by a period of recession (both above the trend line), then depression as the decline continued below the trend line, and finally a period of revival as the economy climbed back toward its trend line.

For Schumpeter all four phases are time periods with duration. For us today, two of the phases have duration, and two are turning points.

For Schumpeter the cycle is like a sine wave, beginning and ending at its average value. For us the cycle is measured peak-to-peak (like a cosine wave) or trough-to-trough, bottom to bottom.

Getting the story straight

The Marxists Internet Archive -- long my source when quoting Keynes -- also offers Geoffrey Pilling's The Crisis of Keynesian Economics. I just looked at it for the first time. I didn't read much, but this stood out right away:

Writing of the decade following the end of the war, J.K. Galbraith said, ‘Within a decade [after 1945] the belief that the modern economy was subject to a deficiency in demand – and that offsetting government action would be required – was close to becoming the new orthodoxy’.

That's Geoffrey Pilling's date in brackets there, not mine.

By 1950 then, give or take, the idea that aggregate demand was insufficient was pretty well accepted among economists... and, Galbraith adds, economists thought offsetting government action was required.

That's important, because it explains why Federal spending remained high. It explains why government spending did not drop back to a low level, as it was before the Great Depression and two world wars.

Graph #1: From Brad Delong's Fiscal Policy in the Shadow of the Great Depression (PDF, 21 pages)

The increase in Federal spending, from less than five percent of GDP to near 20 percent, was not an accident. Nor was it a conspiracy (liberal or otherwise). It was economic policy, designed to boost economic performance and to create both jobs and profits through free-market processes.

Golly.

Comparative Economic Policy Outcomes

Tom Hickey links to Russia 'Capital Outflow' Is Actually Companies Reducing Debt at Russia Insider:

Due to sanctions instead of rolling over their debt like everyone else does Russian companies are forced to repay it. Also means that unlike everyone else they're going to have very little debt.

And from the article:

Central Bank of Russia released full-year 2014 capital outflows figures, prompting cheerful chatter from the US officials and academics gleefully loading the demise of the Russian economy...

In simple terms ... USD 118 billion or 78 percent of the catastrophic capital flight out of Russia in 2014 was down [due] to debt redemptions in banking and corporate sectors. Not 'investors fleeing' or depositors 'taking a run', but partially forced debt repayments.

[M]ost of the capital flight that Western analysts decry goes to improve Russian balance sheets and reduce Russian external debt. That can't be too bad, right?

Not too bad.

I don't know why... Hey, external debt can be a problem, sure. Any debt can be a problem, if there's too much of it. But I don't know why the emphasis is always on external debt, or government debt, and never on private debt. Never on the big one.


Tom's link caught my eye. Just the other day I made a prediction:

The first of the great powers to reduce private debt will be the world's next hegemon.

Could it be Russia?

Don't laugh. I know you want to laugh. It's a natural response, given the cheerful chatter and the gleeful gloating we've been exposed to from the idiots in our idiot boxes. Just remember it. Remember: you want to laugh at the thought that Russia could be the world's next hegemon.

See where China is today? Remember where China was when Nixon decided to be friends? It would be like taking candy from a baby, doing business with China.

Not any more.

Russia? I don't know. I don't make predictions. I never make predictions. That was a fluke, that one. (Anyway, it wasn't so much a prediction as a way to present a concept.)

Maybe the Russian economy will get bogged down in its own internal debt, as we have, as Japan did, as China yet may. It's a very common fate. Maybe Russia will be crushed by debt.

Maybe they won't.


You want to know who will be the hegemon. I want you to know that it depends on comparative policy outcomes and debt minimization. The first to reduce private debt becomes the first that is ready for vigorous growth.

Go Billy!

Bill Mitchell:

6. The FIRE sector is the “the most commonly cited source of wealth for billionaires on this list” – in other words, the wealth has been predominantly accumulated through non-productive activities.

I like that bold terminology.

Disputations

From Discourse on Method at adelaide.edu.

I have never observed that any truth before unknown has been brought to light by the disputations that are practised in the schools; for while each strives for the victory, each is much more occupied in making the best of mere verisimilitude, than in weighing the reasons on both sides of the question

Verisimilitude: The appearance of being true or real.

eBooks @ Adelaide

I recently found ebooks at adelaide.edu. Turned up in a Google search.

https://ebooks.adelaide.edu.au/

Nicely formatted. A pleasure to have on the screen.

Recommended.

Methods versus Premisses

Syll says the University of Greenwich shows the way! He quotes Sara Gorgoni from the Rethinking Economics blog. But Syll omitted Gorgoni's opening:

The 24th of November was an important day for the economists at the University of Greenwich, when four programmes ... were successfully reviewed...

The revised programmes were commended for “the enthusiasm and development of new material by the teaching team, showing a flexible and responsive approach to the current environment, as well as taking a leading role in the sector”. That is, they were praised for leading changes in the way economics is taught.

They were praised for changing the way economics is taught.

Is that the key, do you think? Was that Maynard's focus in the General Theory? There's nothing wrong with what economists teach. It's just the way that they teach it.

I don't think so, no. It goes much deeper. As Gorgoni writes, "students themselves have recognised that the tools and theories they learn don’t enable them to make sense of the world they live in".


Maynard dealt with difficult questions of theory -- not how questions were asked, but what questions, and what was wrong with the answers. What was wrong, he said, was not the "superstructure" but the "premisses".

Change enough premisses, and the whole structure falls like Jenga.

Keynes wrote: "Moreover, the characteristics of the special case assumed by the classical theory happen not to be those of the economic society in which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience."

Sounds like what Gorgoni's students are saying.

Human nature

From Duke Today:

A new study from Duke University finds that people will evaluate scientific evidence based on whether they view its policy implications as politically desirable...

“The goal was to test, in a scientifically controlled manner, the question: Does the desirability of a solution affect beliefs in the existence of the associated problem? In other words, does what we call 'solution aversion' exist?" Campbell said.

"We found the answer is yes..."

Toward clarity

You will notice that I am using strong language. I am prepared to admit right away that I may be dead wrong in my judgements. But there is no point in pussyfooting. Bluntness may lead to an interesting discussion.

- Robert Solow

From the Standup Economist ...

... at Philip Greenspun's Weblog:

Steve Keen, exactly right

Steve Keen:

... a private debt crisis can’t be solved simply by increasing public debt. If deleveraging is to really occur and allow a real private sector revival, then private debt has to be substantially reduced by deliberate government policy.

A lot of people who should readily accept Keen's view get tangled up instead in what they think Keynes would do. They want to do the Keynesian thing. They want to increase government spending. They think that's solution enough.

They forget that we have been relying on the Keynesian solution since the Great Depression. We did increase government spending. And it worked. It kept us going, far past the point when the burden of private debt should have brought the economy crashing down. Unfortunately, this means that the burden of private debt today is far beyond anything that could be called "sustainable".

What is necessary is to restore balance between public and private debt. The solution, this time around, is not further increase in government debt, but a reduction of private debt. But we are a nation that uses credit for growth, and we have created advanced institutions and advanced technologies that further the growth of credit. What this means is that every time the government boosts spending by a dollar, we boost private credit use and private debt by more than a dollar. Or we did, until it created the crisis:

Graph #1: Change in Private Debt, per Dollar of Change in Federal Debt (by Sector)

Until about 2008, households and nonfinancial corporate business and financial business, each of them tended to create more than a dollar of new debt for each new dollar of Federal debt. Total up those private components, and it is even easier to see private debt growing faster than Federal debt.

Since the crisis, private debt has been growing more slowly than Federal debt. Perhaps this suggests that we don't need "deliberate government policy" to substantially reduce private sector debt. But if that solution works, if increased public spending and debt works, if it restores the health of our economy, then private debt will grow faster again. In a growing economy, we use lots of credit. Private debt will grow faster than Federal debt, monetary imbalance will grow worse again, and the problem will not have been solved.

To solve the problem, we have to prevent the future expansion of private debt. We can do that easily by setting up incentives that accelerate the repayment of private debt, and by using those incentives as a way to fight inflation, instead of always and everywhere relying on the mind-numbingly stupid policy of raising interest rates.

But that is a problem for the future. That is a problem for a time after our economy has been restored to health. Meanwhile, the quickest way to restore our economy is to set up those incentives today, to reduce private debt today, to reduce financial cost today, to encourage the growth of the non-financial economy today. Think of it as a deliberate government policy.

Yes, certainly, policy must provide more money so the economy can function. That's where Federal spending comes in. But maybe -- and this is something to think about -- maybe there is enough Federal debt already, if we reduce the growth of private debt.

We must reduce private debt because it creates a financial cost that undermines profit, income, and aggregate demand. We must provide an alternative money, one that does not carry such cost. Let the Federal government spend, if need be, and see to it that the Federal Reserve buys up enough Federal debt to push up the amount of low-cost money in our economy, to bring down the ratio of "costly money" or "credit in use" or "debt", relative to money that does not cost interest and need not be repaid.

This is the key ratio, high-cost money relative to low-cost money. It determines whether times are good or hard. It determines the state of economic health and vigor. It determines whether we survive as a nation, and as a civilization.

A prediction

The first of the great powers to reduce private debt will be the world's next hegemon.

Yes, and you find the same problem in private debt

Oilfield Trash alerts us to Steve Keen's Outlook 2015 (PDF, 20 pages, lots of graphs).

From the PDF:

Figure 1: Private debt bubbles everywhere

Want evidence that debt is the problem? Note that private debt in Japan peaks 20 years before private debt in Europe, China, Australia, and the United States.

Look, a lot of people say No, debt's not the problem. The problem is inequality.

Here's the thing: We have to stop saying "no". I want you to stop saying No, debt's not the problem. I want you to start saying Yes, and you find the same problem in inequality.

It's the same problem. "Inequality" is how it shows up among people. "Debt" is how it shows up in economic data. It's not two different problems. We don't need to fight about that. If you want to think of inequality as the problem, and think of debt as evidence of the inequality problem, that's fine with me. But we have to stop saying "no".

We have to start agreeing with each other. Otherwise, the people who disagree with both of us will win the day.

Nutting could be finer

Rex Nutting:

... the income of the top 0.01% of earners (the top 1 in 10,000) has increased at a 6% annual rate since 1979 (compared with a 1% increase for the bottom 90%.)

The top 0.01% of earners are overwhelmingly corporate managers, top executives in finance, corporate lawyers and investors. This group makes an average of about $16 million a year, or about $300,000 per week.

This imbalance between the ultra-rich and everyone else would be fine if it were fair, if winners were really rewarded for excellence, and losers really lost, but that’s not the way business works. CEO pay isn’t based on excellence, but on rent-seeking behavior that increases their pay far above what is economically justified.

No.

More specifically:

This imbalance between the ultra-rich and everyone else would be fine if it were fair, if winners were really rewarded for excellence, and losers really lost...

No.

The economy is a game of wealth accumulation. One of the forms of wealth that we accumulate is money. Money is a unique form of wealth because it is the one used in exchange for other forms of wealth -- when you receive your paycheck, for example, and when you spend it. Money is the one form of wealth that facilitates the accumulation of all forms of wealth. So, when money's been all accumulated, the economy can no longer function.

Even if wealth accumulation was "fair", the economy couldn't function. Even if things were perfectly equal, if we all had accumulated equal amounts of everything and had equal wants remaining (ridiculous as the notion is) the economy could not function. Money needs to circulate, to facilitate transaction. When too much of the transaction medium has been accumulated, saved, and withdrawn from circulation, the economy cannot function. In that ridiculously equal world, we would all be sitting on our wealth at zero percent, bemoaning the economic decline.

The kind of wealth and income imbalance Rex Nutting is talking about is not "fine". It puts the economy in failure mode. It makes things go bad. It makes capitalism evolve to some other, more authoritarian form. It's not "fine" at all.

A word from John Kenneth Galbraith

From A Short History of Financial Euphoria:

The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version. All financial innovation involves, in one form or another, the creation of debt secured in greater or lesser adequacy by real assets. This was true in one of the earliest seeming marvels: when banks discovered that they could print bank notes and issue them to borrowers in a volume in excess of the hard-money deposits in the banks' strong rooms. The depositors could be counted upon, it was believed or hoped, not to come all at once for their money. There was no seeming limit to the debt that could thus be leveraged on a given volume of hard cash. A wonderful thing. The limit became apparent, however, when some alarming news, perhaps of the extent of the leverage itself, caused too many of the original depositors to want their money at the same time. All subsequent financial innovation has involved similar debt creation leveraged against more limited assets with only modifications in the earlier design. All crises have involved debt that, in one fashion or another, has become dangerously out of scale in relation to the underlying means of payment.

Financial Business Debt

The graph shows Financial Business; Credit Market Instruments; Liability, Level, Billions of Dollars, Annual, Not Seasonally Adjusted, or TCMDODFS at FRED. The trend line is exponential, by Excel, based on the years 1950-1975, just like the past two days' graphs.

The graph shows financial business debt hugging the early trend not for 25 years, but for a full 50. Only around 2002 does the debt fall away from trend -- slowly at first, massively after the crisis.

Business Debt

Graph #1

The graph shows Nonfinancial business debt, and an exponential curve based on the early years. The blue line is the sum of two FRED series:

• Nonfinancial Corporate Business (NCBTCMDODNS), and
• Nonfinancial Noncorporate Business (NNBTCMDODNS),

both annual, both in billions, etc., etc., etc.  The exponential curve is an Excel trendline based on the years 1950-1975, just like the Household Debt graph from yesterday.

Graph #1 shows business debt growing faster than trend in the latter 1970s and '80s, then slowing until about 2000, then slowing further. You could say the 1978-2000 path is an S-curve where business debt still followed trend, and business debt has been falling below trend since 2000. Or you could say business debt growth has been declining since 1990. You'd be right either way.

If you are patient and attentive, you will have noticed that this is the third in a series of posts comparing debt to trend, sector by sector. Me... my mind wanders. I look for entertainment. That takes us this time a little off-topic. Think of it as background.

Graph #2

The blue line on Graph #2 is the same as on Graph #1, the sum of two FRED series. Red is corporate. Green is noncorporate. Both are nonfinancial. (Tomorrow we look at financial debt).

Nonfinancial corporate (red) is higher than nonfinancial noncorporate (green). But both lines vary, and both trend upward, so it is hard to see how they compare. So we turn to graph #3:

Graph #3

Graph #3 shows how much (nonfinancial) corporate (business) debt there was, for each dollar of (nonfinancial) noncorporate (business) debt since 1950. It falls from three dollars to a dollar and a half, then rises to two and a half, then falls to a dollar and a half again, and appears now to be on the rise again.

It's easy to want to think of Graph #3 as showing the relative size of corporate and noncorporate business. Probably not a good idea. There are better measures of business size. This just compares debt size.

Household Debt

The graph shows debt of Households and Nonprofit Organizations (HSTCMDODNS at FRED), annual data, 1950-2013, in blue. The graph also shows the exponential trend of this debt for the early years, 1950-1975.

The graph shows that the growth of household debt remained close to its 1950-1975 trend until the crisis. In other words, household debt grew at pretty much the same rate before 1975 and after.

By way of contrast, the gross Federal debt grew much faster after 1975 than before -- based on the graph we saw in the previous post. Government debt grew slowly until the mid-1970s, when the rapid growth of private debt caused a slowdown of economic growth and something had to be done.

It's fun to say the growth of government debt is the problem. Fun, but it's not right.

"Civilizations die from suicide"

Gross Federal Debt

Graph #1: Gross Federal Debt (blue) and the Golden Age Trend (red)

The red line is an exponential curve based on the Federal debt of the Golden Age. Think of it as showing what the Federal debt would have been if we didn't grow the Federal debt since the 1970s in an effort to restore economic vigor.

People today say the growing Federal debt is a problem. It is important to remember that in the 1970s and '80s the growing Federal debt was a solution.

Federal debt growth failed as a solution because it didn't grow faster than private debt. That didn't happen because of all the "safety-net" stuff that postponed the crisis since the 1970s. Because we prevented economic collapse back then, we didn't get a private debt collapse back then, and private debt just kept getting bigger.

So private debt kept getting bigger, and since the 1970s when it became a problem, the Federal debt has been getting bigger in an effort to solve the problem. So now, both the private and the Federal debts are massively big. And apparently, there are two kinds of people in the world: those who complain about the size of the Federal debt, and those who do not complain about the size of Private debt.

There cannot be a good ending when all debt is massively big. But the only remaining option -- and the only one we have not tried -- is to reduce private debt. Policymakers refused to do that, and debtors could not (because policy undermined their efforts). So at last, the economy took up the challenge and gave us an economic crisis. And for a few years, private debt fell.

But this is not a thing we can leave to chance. We must learn that keeping private debt to a low level is a good thing; and policymakers must learn it also.

And policymakers must act.

Failures and TCMDO Growth

Failures and TCMDO growth are not unrelated:

I took "Failures" from earlier today, put it in context (i.e., divided by inflation-adjusted GDP), showed it in blue, and put the annual percent change in TCMDO debt on the same graph. (The debt number is scaled down to make the two high points roughly equal.)

There is definitely a relation between "failures" and the decline of debt. So, there is definitely a relation between  debt growth and economic growth. I just think we need to be careful and cautious when we attempt to describe that relation.

//

Looking again at the above graph... It is interesting that the high peak in the blue line seems to occur at the same moment as a "secondary" drop in the debt trend. After 1970 the red line shows three substantial peaks, and three "bottoms" that seem to sustain the general upward trend of debt growth. The last of those three bottoms comes just before 1990 and just after the red and blue lines cross: the red line briefly jogs upward again.

But that is the moment that the blue line peaks; and concurrent with the fall from that great blue height the red line drops, making a substantial departure from its general upward trend. I think that's interesting; I wonder what policy was doing just then; and I wonder in particular whether monetary tweaks had anything to do with it.

"I wonder in particular whether monetary tweaks had anything to do with it." Before you object to that thought, please recall that debt is a monetary phenomenon, and that a "fiscal" policy of deficit spending is very much a monetary tweak.

Failures

U.K. Prices since 1209 (Measuringworth)

"Reductions in the growth of private debt have been associated with every recession for the last 50 years."

It is one thing to say, as Auburn Parks says, that "every recession for the last 50 years" has been associated with "reduction in the growth of private debt".

But that is not the same as saying every reduction in the growth of private debt creates a recession (which is what Auburn seems to want to say).

I can accept implicitly that when there is a recession, the use of credit will fall. But I do not accept the assumption that whenever the use of credit falls, recession is certain.

And even if it is true that there was a recession every time credit-use fell in the last 50 years, it does not mean the economy has to work that way. All it means is that policy has set things up to work that way.

And if it is true that policy set things up to work that way, then the real problem is the thinking that underlies policy. The real problem is the flawed assumptions that underlie policy.

//

To summarize the thought: Reduction in the growth of private debt need not be associated with recession. You want to keep that in mind when you think about the design of policy.

It also explains why the fiscal multiplier is low.

In comments here on the problem with Quantitative Easing, Auburn Parks said:

The real problem with QE is that it doesn't add any Govt liabilities for the private sector to hold as wealth.

I quoted that back to him and replied:

So you are saying that the real problem with the economy is that there is not enough financial wealth for the private sector to hold? You would have to convince me.

Geerussell said:

This is a great excuse to roll out this old chart from way back.

He linked to this graph:

Graph #1: Dollars of Private Debt for each Dollar of Federal Debt (black line, right scale)

The graph shows a measure of private debt (red), a measure of Federal debt (green), their sum (blue), and their ratio (black). The black line shows that, for every dollar of Federal debt, there was from four to six dollars of private debt (reading the right-side scale). Then, in the mid-1990s it went to eight dollars of private debt, and in the 2000s it went briefly to nine dollars of private debt for every dollar of Federal debt.

Geerussell writes,

There are two ways to reduce the burden of debt. Reduce [private] debt, or increase the equity on which it rests. I'd say there's a pressing need to pursue both avenues.

Geerussell's point is that if the high level of private debt relative to Federal debt is a problem, then we can solve that problem either by reducing private debt or by increasing Federal debt. Or both.

I can't argue with that arithmetic. But I look at things differently. If the high level of private debt relative to Federal debt is a problem, I want to understand why the ratio is so high. I ask: Why is private debt so high? and Why is Federal debt so low?

Funny, isn't it? Federal debt is NOT low. It is only low relative to private debt, because private debt is so massively big. Anyway, apparently both Geerussell and Austin Parks would be happy to see the Federal debt increase. I'd rather see private debt decline.

Why is private debt so high? If we don't answer that question, private debt could stay high despite a significant increase in Federal debt. I mean, if we grow the Federal debt on purpose to make the black line fall, private debt might increase faster also, so that the black line does not fall. If the black line does not fall, the ratio remains high.


Here is an updated version of the previous graph:

Graph #2: An Updated, Longer-Term version of the Black Line on Graph #1

Graph #2 goes back two decades further into the past than #1. It also uses improved measures of public and private debt. So the high values achieved on Graph #1 are only about half as high on #2: four instead of eight in 2001, 4½ instead of 9 in 2008. But the two graphs show the same pattern.

Economic growth in the 1950s and '60s was generally good, supported by strong and persistent growth of debt -- as you can see from the strong uptrend on the graph during those decades. There was a little hesitation in 1967 and again during the 1970 recession, as the ratio reached  2.5-to-1 and 3-to-1. Then, from the 1974 recession to the early 1990s the ratio ran flat or trended slightly down. Economic performance was not impressive in those years, because debt and financial costs had already reached a high level.

Eventually the ratio fell a bit, and by the mid-1990s started climbing again. And the economy was good again, while the ratio climbed. But climbing pushes the ratio higher; financial costs take more of a bite out of profits and aggregate demand; and the economy slows again.

Finally, the burden of debt broke the economy, we had the crisis and "great recession", and the ratio started falling. It is lower now than it was at the onset of the 1990s boom, and that is promising. But at $2.5 dollars of private debt per dollar of gross Federal debt, the ratio is still high today.

It was increase in the private debt ratio that made vigorous growth possible; we see this 1950-1970, we see it 1994-2000, and we could see it again soon.

Increases in private debt make the economy vigorous. But the increases push the ratio up, making further increase less likely. And when the ratio runs high, the economy runs into trouble. We need the ratio low in order to attain a sustained period of economic vigor.


Is increased government participation the solution to the problem? Well... Was there a fall in government participation that caused the problem?

No. Government participation did not fall:

Graph #3: Debt in Billions -- Total Private Debt (red) and Gross Federal Debt (blue)

The high ratio could have been caused by the fall of government participation, or by the rise of private participation. But government participation did not fall. It grew. So the high ratio was not caused by the fall of government participation. So it must have been caused by the rise of private participation.

We use credit for growth; therein lies the problem.



I worried above, that

if we grow the Federal debt on purpose to make the black line fall, private debt might increase faster also, so that the black line does not fall. If the black line does not fall, the problem remains.

That is in fact what we see between 1971 and 1991 on Graph #1. The black line wanders along a horizontal trend path. This means that private debt was increasing at about the same rate as the Federal debt.

You can see it on Graph #2 also: the red line runs roughly flat from 1970 to 1990. So if it is true that the Federal government increased spending and deficits in an attempt to restore economic vigor to our flagging economy, then it must be true that private debt increased more rapidly also -- at about the same rate as the Federal increase.

Graph #4 shows the Gross Federal Debt as given in FRED's FYGFD series. That's the blue line. The red line is an exponential trend line generated by Excel for the years 1945 to 1974:

Graph #4: Gross Federal Debt (blue) and the Golden Age Trend (red)

The red line is an exponential curve based on the Federal debt of the Golden Age. Think of it as showing what the Federal debt would have been if we did not grow the Federal debt on purpose to restore economic vigor.

Think of the gap between the red and blue lines as extra debt accumulated in the process of trying to drive the private/public debt ratio down. Trillions and trillions and trillions of dollars.

Did all that extra Federal debt push down the ratio on Graphs #1 and #2? No, it did not. We know that private debt and Federal debt grew at about the same rate for near 20 years, from 1970 to 1990 or so. Twenty years of unimpressive economic growth. The boost to Federal spending created an inadequate boost for the economy because private debt remained high.

If your plan is to fix the economy by expanding government spending, well, your plan has already been tried. It didn't work.

Why didn't it work? To be blunt, it didn't work because we didn't have a Depression in those years. A Depression would have wiped out a lot of private debt while the government spending was pumping money into the economy. That didn't happen.

Instead, the private sector took every new dollar of government money and diced it up into many more dollars of private lending and debt. Instead of falling, private debt increased.


Why is private debt so high? Because we have many policies that encourage the use of credit, and no policy that encourages repayment of debt.

Increasing Federal spending and Federal deficits will not restore vigor unless policies are put in place to limit the expansion of private debt -- for example, by tax incentives for accelerated repayment.


Related posts:

Debt Relatives: The Cousins

FRED: Federal spending as a % of GDP (blue) and Federal deficits as a % of Federal spending (red)

More cowbell

FDR and the hodgepodge story

From Try Everything by Brad DeLong:

When it became clear in late 2008 that the global economy was headed toward a crash at least as dangerous as the one that had initiated the Great Depression, I was alarmed, but also hopeful. We had, after all, seen this before. And we also had a model for how to mitigate the damage; unfortunately, policymakers left it on the shelf.

For three and a half years following the start of the Great Depression, US President Herbert Hoover’s top priority was to balance the budget, trying – but ultimately failing – to restore business confidence. In 1933, newly elected President Franklin D. Roosevelt changed course, adopting a simple yet radical strategy: try everything that might boost demand, increase production, or reduce unemployment – and then keep doing the things that work.

Roosevelt abandoned attempts to balance the budget, increased the money supply, and initiated deficit spending. He took the United States off the gold standard, had the government hire workers directly, and offered loan guarantees to those in danger of losing their homes. He cartelized the oil industry and instituted aggressive antitrust policies to break up monopolies.

Brad DeLong's model of what FDR did is a hodgepodge. FDR tried everything, DeLong says. I've seen that story before. But I have trouble with the hodgepodge story.

Oh, I don't deny that FDR did all sorts of things. "Bold, persistent experimentation" he called it, if I remember my Leuchtenburg. But it was no hodgepodge.

FDR did one thing. He reduced the debt-per-dollar ratio.

The turning points shown on this graph at 1933 and 1947 correspond remarkably with the beginning and the end of the FDR administration.

Their way of thinking...

If you get the FRED graph of GDP and click the NOTES tab, you'll find a link to the nipaguid (PDF, 28 pages). I still think it's funny that they still use an 8-character filename for it. But that sure will come in handy if you're using DOS 3.2...

A Guide to the National Income and Product Accounts
of the United States

Here's the bit that got me writing:

The most recent comprehensive revision of the NIPAs, which was released beginning in 2003, further improved and updated the accounts. For example...

An improved measure of banking services that includes the services received by borrowers was introduced; previously, such services were only allocated to depositors.

Because of that revision, the work of lenders who created our massive private debt is now included in GDP. So GDP is bigger, and the ratio of debt to GDP is less, because the work of creating debt now counts as part of GDP.

Buying a used car from your neighbor? No, that's not in GDP.

Raising your own children and doing your own housework? No, that's not in GDP.

Capital gains? No, that's not in GDP.

But creating more debt? Yeah, we count creating debt in GDP.

The mindset is the problem. We think...  They think creating more debt is a good thing. That is why they can't fix the economy. Everybody who breathes wants to reduce his own debt, wants to reduce her own debt; but policymakers make policy to encourage private debt creation -- and bean counters count private debt creation as a plus.

This is why they cannot fix the economy. They think what they're doing is good.

Bots

Snapshots from late evening, 28 December 2014:

The Past Month

The first graph shows a real increase in pageviews per day, during the past two weeks. (The line drops way down at the right end because, at the time I took the snapshot, only about two hours of the day were counted. The "day" starts around 8 or 9 at night.)

The Past Week

The second graph shows that a lot of the pageview activity occurs in bursts. Either a lot of people visit the blog all at once, or one visitor views a lot of pages in a short time.

The Past Two Hours

The third graph shows that some visitors do stop by to read a post or two. Thank you! And then, just before 9PM, there were 15 pageviews or more, all within one minute.

So it goes.