Following-up on yesterday's evaluation of Scott Sumner's graph.
Here's my re-creation of the graph Scott Sumner showed on 3 January 2016, which I looked at on the 6th:
|Graph #1: Currency Relative to GDP (blue) and the Interest Rate, à la Sumner|
Notice that the two variables tend to move inversely. After 2008, the yield on T-bills fell close to zero, and the demand for cash soared from just over 5% of GDP to just over 7%.
Just to be clear about what Sumner is saying, I marked up a copy of the above graph to show the "just over 5%" and the "just over 7%" and exactly which part of the blue line he is talking about.
|Graph #2: A Markup of Graph #1|
Sumner's argument is that "the demand for cash is negatively related to the market interest rate". That is what his graph shows. The demand for cash (blue) falls for the whole left half of the graph, while the pukey-red market interest rate is rising. And for the whole right half, the blue line rises while the pukey line falls. As Sumner put it, "the two variables tend to move inversely."
Yes, what we see on Sumner's graph is the same as he has described. I had some complaints yesterday about his graph. Have no fear, I have those same complaints today. But to be fair and balanced here, I wanted to be clear on what Sumner said about his graph.
That's out of the way now.
Scott Sumner is telling us that interest rates influence how we hold our money. When rates are low, he says, we hold more of our money as cash. And when rates are high he says, we hold less of it as cash. As I noted yesterday, it's a reasonable argument and it makes sense.
But I do graphs. It's what I do. I can't tell you why his graph bothers me. But it bothers me, and I do graphs. So I had to look at Sumner's graph and see if it made sense or not.
That was yesterday's post.
Today ... today I was looking at his graph again because it shows money relative to GDP ... and I also show money relative to GDP, but different money ... and Milton Friedman also showed money relative to GDP -- but a different GDP.
(Look, in Money Mischief, Friedman used "national income" for GDP. But that's not the different that I'm talking about. National income is either the same as GDP or a bit less, it seems, depending who you ask on the internet. But they run together, GDP and national income. There's no big difference between them. Friedman, though, didn't just use national income: He used "real national income", which is national income with the numbers changed to take inflation out. It's what national income would have been, if prices never went up at all. And that's a big deal. That's what I mean by a different GDP. But that's off-topic. Shame on me.)
Today I was looking at his graph again, Sumner's graph, and it was bothering me, again, and it wouldn't leave my mind alone. Here: If Scott Sumner wants to show that we hold more of our money as cash when interest rates go down, he has to show us the money we hold as cash, compared to all the money we hold. That's what more of our money as cash means: our cash as a share of our money.
He doesn't. He shows the money we hold as cash, compared to the size of the economy. Should be, compared to all the money we hold. Like this:
|Graph #3: Currency as a Percent of M1 Money (two measures).|
The red line is the better measure, in my view.
Currency relative to the money measure provides a good picture of our inclination to keep our money as cash. Currency relative to GDP, the measure Sumner uses, does not.
I have to assume that Sumner used currency relative to GDP on his graph because it gives results that by dumb luck appear to support what he's saying. And that's very nice for him, because apparently most people don't question graphs. Most people take graphs as evidence. I know I usually do.
Maybe that's why I'm so troubled by Sumner's graph, this time.