Thursday, February 26, 2015

Burping it up again

This is an old one, from 7 September 2014. I think it's good, and worth repeating.

Let's draw a conclusion

At FRED Blog: How much money is the Fed printing?

To answer that question they look at currency in circulation. Two graphs.

First graph:

 Graph #1: Quantity of Money, in Natural Log Values
Before 1960, flat. After 1960, straight-line increase.

The graph uses natural log values to show growth rates. As the FRED post says, "if the slope is the same for two years, the growth rate is the same." A more upward slope is faster growth. A less upward slope is slower growth.

The FRED post says the values are "indeed increasing, but there is no indication that it is accelerating". In other words: The line goes up, yes, but after the early 1960s it doesn't curve up.

Second graph:

 Graph #2: Quantity of Money Relative to GDP
Graph #2 shows the same money as Graph #1 but shows it a different way. No "log" numbers. Instead, the graph compares the quantity of money to GDP. On Graph #2 we have downtrend to about 1985, and then uptrend: The currency component of M1 grew more slowly than GDP in the early years, and more quickly than GDP in the late years. I want to say the change occured around 1985.

Leave out the years before 1960 where Graph #1 has the flat trend. Look at the years since 1960, where #1 shows a straight-line uptrend.

From 1960 to 1985 the trend is down on Graph #2. After 1985 the trend is up. And yet, as the FRED Blog says, Graph #1 shows no acceleration.

Graph #1 shows that currency growth did not change. Graph #2 shows that either currency growth or GDP growth did change. We have to put the two facts together in our head: Either currency growth or GDP growth did change, but currency growth did not change. Therefore, GDP growth changed.

Voila.

To confirm, I took a quick look at the numbers.

During the 25 years from 1960 to 1985, currency in circulation increased by a factor of 5.6. During the 25 years from 1985 to 2010, currency in circulation increased by a factor of 5.5. Almost exactly the same. So, a straight line increase it is. As FRED said.

During the first 25 years GDP increased by a factor of 8.0. That's faster than currency growth, so the line on Graph #2 goes down between 1960 and 1985.

During the second 25 years GDP increased by a factor of 3.4. That's slower than currency growth, so the line on Graph #2 goes up between 1985 and 2010.

Currency growth was the same for the two periods, even though the "Great Inflation" is entirely contained in the earlier period. Currency growth was the same, but GDP growth was different. GDP growth was much faster in the early period, and much slower in the second.