Saturday, July 25, 2015

Is 1+1 the cause of 2? Of course not.

Is it a serious comment? A joke? Some weird spam? Sometimes I just can't tell.

A few months back, Noah Smith gave us Why did rich-world deficits start exploding around 1980? I gave it right back to him with They didn't:

... deficits were trending up since the 1950s. Deficits were trending up quickly since 1970. If deficits were growing quickly since 1970, why does Noah's debt graph not show increase until ten years later?

Because inflation skews the numbers, that's why.

In his post Noah offers "a theory" to explain the "explosion" of deficits that "started" around 1980. Noah has "the VCG mechanism" and "the AGV mechanism" and "a big caveat" and more. It's a big, complex explanation of something that never actually happened.

"It's really striking," Noah says, "that deficits started trending upward all over the rich world around the same time." For crying out loud, Noah: The Great Inflation was coming to an end all over the rich world at that time:

Graph #1: All Over the Rich World, Inflation Came Down in the Early 1980s
Source: Index Mundi
NOTE: Noah says deficits started trending upward in the early 1980s. But he is looking at debt relative to GDP, and he ignores the GDP component. In fact, a good part of his uptrend is due to the slower GDP growth resulting from the decline of inflation -- a decline that was seen "all over the rich world". Thus is Noah's "striking" fact explained.

High inflation erodes debt. Low inflation doesn't.

The end of the Great Inflation reduced the growth of nominal GDP. So at that time, the debt-to-GDP ratio stopped being pushed down by inflation. The ratio went up since the early 1980s because inflation was less since the early 1980s. Not because deficits suddenly exploded. The explosion of deficits (if you have to call it that) came in the 1960s and '70s, during the Great Inflation. See for yourself:

Graph #2: U.S. Deficits Increased till the 1960s, Increased Faster till the 1980s, then Declined.
There is no "explosion" of deficits beginning in the 1980s.

The explosion of deficits ended in the 1980s.

There was a recent comment on Noah's post, just the other day, from Suresh Nanjagurd. "You are making this way too difficult," Suresh told Noah. "Deficits are caused when spending > income. Pretty simple, but then I'm just a humble chemist and not an economist."

Deficits are caused when spending > income.

He is joking, I hope.


The FRED graph:
The Excel file with data from the FRED graph, my Graph #2, and some VBA code.

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