Hey Jude. Hey Noah.

This quote from Jude Wanniski

you have to have lived in the 1950s and 1960s to have experienced a good economy.

reminds me of this quote from Noah Smith:

Thirtysomethings like myself - the leading edge of the Millennial generation - often speak with reverent nostalgia of the 1990s... Twentysomethings - the younger Millennials - are confused by this. What made the 90s so amazing?

But Noah doesn't know what made the '90s so amazing. He offers a list of amazing things that happened. But he can't come up with a story that tells what made those things possible. Noah:

The 1990s saw the explosion of information technology ... the progress of gender equality ... Race relations also seemed to be improving in the 90s ...

but also crime:

The 1980s and early 90s saw an enormous crime wave...Then, suddenly, crime dropped off a cliff. In a few short years, the murder rate dropped to levels not seen since the golden years of the early 1960s...

Funny that crime dropped after the early 1990s to levels not seen since the 1960s. Crime seems to drop when the economy is doing well. I once worked with a guy who described his time unemployed this way: "Things got so bad, I was starting to steal."

So it goes.

The 1960s were good. And the latter 1990s were pretty good. Why is that? This is what Noah was asking. What made the economy so good at those particular times?

It was a relatively low level of private sector debt that made the economy good. Debt was low enough that people were willing to take on more debt, which meant people were buying more stuff, which meant aggregate demand was running high, which meant employers were hiring, which meant the economy was good.

Unfortunately, when people are taking on more debt, the level of private sector debt does not remain low for long. When it goes up, financial costs begin to interfere with growth. The economy loses its luster.

Graph #1: Dollars of Debt per Dollar of Spending-Money in the U.S. Economy, 1916-2015

The economy was good for about 20 years (1947 to 1966) after debt fell for 15 years in the 1930s and 1940s. The economy was good for a few years (the latter 1990s) after debt fell for a few years (the early 1990s). The economy will be good again, after debt has fallen far enough this time. But things remain precarious because the level of debt remains so high.

Scott Sumner'd tell you the economy's bad because money's tight. He's right about that, but he doesn't know how to show tight money. To see tight money, look at spending-money relative to accumulated private debt -- or to total public and private debt, like the graph. Look at narrow money relative to broad money. Look at the cost of finance relative to the money available to make payments.

Super simple stuff.

"it is vitally important to be realistic about the impact of policies on the performance of the overall economy" -- Romer & Romer

The most disturbing part of the Open Letter criticizing Gerald Friedman's analysis of the Sanders plan:

Making such promises runs against our party’s best traditions of evidence-based policy making and undermines our reputation as the party of responsible arithmetic.

And the most disturbing part of Romer & Romer's Senator Sanders’s Proposed Policies and Economic Growth (PDF, 11 pages) to me is their claim that the predicted economic improvement is "far too large to be credible". (Emphasis by Romer & Romer.)

Unrealistic. Too large to be credible. Too good to be true. That's not evidence.


Romer and Romer object to Gerald Friedman's projection of 5.3% average annual output growth over the next decade. They consider it unrealistic. It's easy to agree with that assessment. But that doesn't make the Romers right.

It's easy to guess the future wrong. Time magazine, 31 December 1965:

The Labor Department reckons that businessmen's exuberant capital spending—they have invested $190 billion in new plants and machines in the past five years—will pay off with a 3% productivity gain in 1966. That will serve to temper inflation...

Economists in and out of Government are much more bullish than they were a year ago. The economy is not only running close to optimum speed, but has no serious excesses and few soft spots.

Obviously over-optimistic.

It's easy to guess the future wrong. But it's just plain sad to think economists today would dismiss an economic strategy simply because they find it too optimistic. We still do need a plan that turns out well.


From Gerald Friedman's paper:

The Sanders economic policy will achieve broad-based and sustained prosperity with the following:

The growth rate of the real gross domestic product will rise from 2.1% per annum to 5.3% ...
Faster economic growth and redistributive taxation will raise the growth rate of median income from 0.8% per annum to 3.5% ...
The unemployment rate will fall to 3.8% ...
There will be sustained increases in real wages ...
The gap between rich and poor will narrow dramatically ...
After increasing in the first years of the Sanders Administration, the Federal budget’s cash deficit will drop sharply ...

(I left a lot out.) The way I look at it, everybody's economic plan has a happy ending. You have to take it with a grain of salt.

But what I want from economists like Romer and Romer is not outright rejection because the happy ending is unrealistic. I want them to throw away their assumptions and look at things with fresh eyes.

I need them to wonder what can we do to make it happen.

The fact that policymakers have been unable to restore vigor to economic growth is not evidence that the goal is unreachable. It is at least as likely the problem is that wrong policies have been used. And for the record, I don't just mean wrong policies that the other guys have used.

The difficulty lies, not in the new ideas, but in escaping from the old ones.

Reaction Times

Reinhart and Rogoff's Growth in a Time of Debt was issued in January 2010 and caused quite a stir.

Thomas Herndon's Critique of Reinhard and Rogoff was issued more than three years later and caused quite a stir.

Gerald Friedman's What would Sanders do? was issued January 28, 2016.

Romer and Romer's Sander's Proposed Policies and Economic Growth was issued February 25, 2016 -- less than one month later and, coincidentally, Thomas Herndon's birthday -- and seems to be creating quite a stir.

Savings

According to the Notes tab of FRED's MZMSL money page, the difference between M2 money and MZM money is that if you start with M2, subtract out small denomination time deposits, and add in institutional money funds, you get MZM money.

According to the Notes tab of FRED's M2SL page, M2 money includes M1 money and some measures of saving.

According to the Notes tab of FRED's M1SL page, "M1 includes funds that are readily accessible for spending."

If I start with M2 money and subtract out M1, then add in institutional money funds, I'll have a measure of accumulated savings.

Graph #1: A Measure of Savings

That gives me a number a little over eleven thousand billion, currently. The standard for inclusion? Stuff that's called "money" -- but not money that's "readily accessible for spending." So I call it "savings".

The M1 and M2 numbers go back to 1959 at FRED, but the Institutional Money Funds number goes back only to 1974. When I add the Institutional to the others, everything gets chopped off at 1974. On the assumption that before 1974 the Institutional number was a legitimate zero (and not simply an unknown) I could extend the data back in time in an Excel graph. If it irritates me enough, I will.

Based on Sumner #31387 that I've been looking at lately, the big chunk of M1 money that is currency really ought to be subtracted from M1 and added to savings as well. "I can assure you that the vast majority of currency is held for saving purposes, not transactions", Sumner says. I might experiment with that change at some point, but not today. Meanwhile, my "savings" number is a conservative estimate.

Graph #2: Circulatings Relative to Savings (monthly data)

Yup, it irritates me. (Didn't take long, did it.)

The graph starts high (circulatings a bit less than half the size of savings) in 1974, falls by a third by the mid-1980s, rises back to its starting level before the mid-1990s, and falls by two thirds before the crisis.

The graph gives the impression that this ratio is all over the place. It isn't. The downtrend from 1974 to 1984 is the last leg of a downtrend that began in the 1940s, at the end of the Second World War. What remains visible here is really quite deceiving.

The sharp rise to peak in the early 1990s is the same increase of circulatings relative to savings, of narrow money to broad, that I show over and over again in the Debt-per-Dollar graph and elsewhere. That's the increase that allowed the economic growth of the latter 1990s to be unexpectedly good.

Everybody says it was computers that made the economy good in the latter 1990s: It was IT. Well, if the economy is good, there has to be some sector that is doing quite well, don't you think? It was time: The technology was ready, and people were ready. But the thing that allowed it to happen was the change in monetary balances during the early 1990s. Without the big increase in circulatings relative to savings, there could have been no tech boom. We would have seen tech muted, as the whole economy had been muted since 1974.

//

Graph #3: Circulatings Relative to Savings, 1915-2013 (annual data)

The red line here shows the same FRED data shown in Graph #2. Except I extended it back to 1959 by assuming legitimate Institutional zeroes back to that date.

See the high spot in the red line just before 1995? That line rises to about 0.45, exactly as we see on Graph #2. Same data on both graphs.

The ratio falls from a peak in the 1940s, as I said above. The red line isn't "all over the place". It is low and muted, below 1.00 for its whole length. Circulatings amount to less than savings for the whole extent of the red line.

The blue line is older data. The two lines don't match up. That's probably why FRED doesn't provide the older data. I got it from the Historical Statistics, Bicentennial Edition.

By the older numbers, circulatings were as much as four times the level of savings. By the newer numbers, circulatings were never greater than savings.

When there's not a lot of circulating money, there's not a lot of money that can be used to pay interest on savings. That's when the economy becomes crisis-prone.

But nobody wants to have less savings. That's why the economy cannot recover.

//

I inverted the ratios. The next graph shows savings relative to circulatings:

Graph #4: Savings relative to Circulatings, 1915-2013

By the old data, savings were never greater than circulating money. By the new data, savings are never less than circulating money.

Policy hint: The economy was good between 1947 and 1966.

What happened in April 1995?

Graph #1: Everything Changes in April, 1995

The graphs Scott Sumner didn't show, and one he did

Reading old posts on my Death of FRED blog I came across Unsaid at FRED, which references the FRED Blog's How much money is the Fed printing? I bring it up because the FRED Blog post shows a graph of the currency component of M1, and a second graph: the currency component of M1 relative to NGDP:

Graphs #1 and #2, from the FRED Blog's How much money is the Fed printing?

That second graph shows the same ratio Scott Sumner used in his Yes, interest rates really do impact the demand for money -- which I have looked at several times of late. Sumner says when interest rates go down, people choose to hold more cash. When interest rates go up, he says, people choose to hold less cash.

It's an interesting idea, I keep saying. But the evidence Sumner shows in support of that idea is no evidence at all. Evidence would be a graph showing the currency component of M1 relative to money in interest-bearing forms. Sumner shows the currency component relative to NGDP. But NGDP is not a form of interest-bearing money. NGDP is not a form of money at all. Scott Sumner's graph is not the evidence he pretends it to be. He needs to be held to account for this.

Look at that currency-to-NGDP graph. It's got the nice "bowl" shape to it. That bowl is the shape you would need in a currency-to-money graph, to show the evidence Sumner wants to show.

Graph #3: Currency Comparison

But not one of the four currency-to-money-measure graphs show a comparable bowl shape. Not M1 money ... not M2 money ... not M3 money ... and not MZM.

I guess you could argue that M2 and M3 show a misshapen bowl of sorts: A sorry excuse for a bowl. To that extent only is there evidence people hold more cash when interest rates are low and all that, that Sumner says.

And that would make sense. M2 and M3 are mostly measures of savings. It is only saved money that people can choose to hold as interest-bearing or as currency. The money that comes as income today and goes as expenditure today, there is no time to hold that money in any form.

Couple comments at Sumner's post are relevant here. Njnnja asks

Who has the hundreds of billions of dollars in currency?

Njnnja runs thru the numbers, and then concludes:

So the response function of currency to interest rates isn’t what the average Joe does to their currency holdings when rates change, but rather, what this unique subset of high-currency holders does.

It's people who hold a lot of money in savings, able to move money into or out of cash, who are chiefly responsible for the relation Sumner describes between interest rates and currency holdings. To the extent the relation exists at all.

The second comment, from Sumner himself, concurs:

I did my PhD dissertation on currency hoarding, and I can assure you that the vast majority of currency is held for saving purposes, not transactions.

It's savers, if anyone, who make currency holdings vary in response to interest rates. Savers and, in our world, the high level of inequality. It's inequality, I think, that makes it so difficult for the rest of us to intuitively see why a change in interest rates would cause changes in currency holdings. Lots of us don't have money to move like that.

Once again, the economy Sumner examines is the high-inequality economy, and the trends he see are those driven by the wealth-holders of that economy.

So, yes: There could be something to it, the relation Sumner sees between interest rates and currency held. But you're damn sure not going to see it by looking at the currency-to-NGDP ratio. NGDP is not money we can choose to hold as currency. NGDP is not money at all. And Scott Sumner's currency-to-NGDP graph is not evidence that changes in interest rates influence currency holdings.


The FRED Blog post looked at the currency component of M1 on a log graph. They said currency is increasing, but not accelerating. They said "if the slope is the same for two years, the growth rate is the same" -- implying you can see it on their graph. As I said at the time: The line goes up, yes, but after the early 1960s it doesn't curve up. It shows a fairly constant rate of increase: increase, but not acceleration.

Then FRED looked at currency-to-NGDP, the same as Sumner uses. They point out the "neat U-shaped long-term trend." Here (somewhat revised) is what I said about FRED's two graphs:

On Graph #2 we have downtrend to about 1985, and then uptrend: The currency component of M1 grew more slowly than NGDP in the early years, and more quickly than NGDP in the late years. I want to say the change occurred around 1985.

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

Graph #1 shows that currency growth did not change. Graph #2 shows that either currency growth or NGDP growth did change. Together, the graphs show that NGDP growth is the one that changed.

I took a closer look:

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. As FRED said.

During the first 25 years NGDP 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 NGDP 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.

 
The "bowl shape" of currency-to-NGDP arises from changes in NGDP growth. Not from changes in currency growth. That's a fact. It doesn't sit well with Scott Sumner's claim that changes in interest rates cause changes in currency holdings. If anything, we would have to say changes in interest rates cause changes in NGDP growth. But I for one wouldn't make a claim like that on such sparse evidence.

The claim Sumner makes would be based on sparse evidence, if his graph was evidence. It is not evidence.

Call him on it.

Nice work, Oilfield Trash!

This comment from Oilfield Trash is the most interesting thing I've read in a long time.

So Scott is saying that Currency Component of MI/GDP is the demand for currency. But that calculation is the inverse of the Velocity of Currency Component of M1 (GDP/ Currency Component of M1).

OT's comment appears below one of my continuing mundane criticisms of Scott Sumner's bogus evidence.

OT continues:

I do not think Scott would argue that the Demand for Currency is the inverse of its Velocity. Although he might.

But more important to me is as the Fed creates more monetary base, short-term interest rates fall in a fairly smooth way.

Having hit zero interest rates some $1.5 trillion ago, further increases in the monetary base have simply pushed us further and further to the left, and velocity has simply declined in direct proportion to base money.

Currently further monetary easing (more base) will do nothing but cause velocity to decline, which gives everyone the idea that monetary policy is too tight.

Of course if you use NIRP the theory is that it removes the constraint of the lower bound and you can pump more base in without causing a drop in velocity. But then again cash hording is an issue and the troubles it brings.

I wonder when demand for 1000 franc notes exceed the supply will it become exchangeable above it par value, which means all other notes are deflating. HMMM something to think about.

http://www.zerohedge.com/news/2016-02-22/safes-sell-out-japan-1000-franc-note-demand-soars-nirp-triggers-cash-hoarding

The zerohedge link brings good perspective to the issue. OT's remarks coupled with the ZH article make a very good analysis of very bad policy.

Where OT says

Currently further monetary easing (more base) will do nothing but cause velocity to decline, which gives everyone the idea that monetary policy is too tight.

I'm thinking: Increasing the base reduces the GDP/Base ratio (i.e. velocity) because GDP increases more slowly than base. And when people (Scott Sumner, for example) see GDP failing to increase, they conclude money is tight.

This is a really good analysis.

You should vote for me because I'm going to win.

How can one empty sentence occupy so much air time?

What does it mean? -- "If you lower interest rates, people will choose to hold more cash."

"If you lower interest rates," Scott Sumner says, "people will choose to hold more cash." He provides this graph showing "the demand for currency (as a share of GDP) and T-bill yields":

"Notice that the two variables tend to move inversely," he says. Sumner uses the graph as evidence of his claim that "If you lower interest rates, people will choose to hold more cash."

I have to ask: More cash, compared to what? More cash, compared to the money people have in total, I think. If you lower interest rates, Sumner is saying, people will choose to hold more of their money as cash.

The argument makes sense: People holding cash don't earn interest on it. If interest rates go down there is less incentive to hold money in an interest-bearing form, and more incentive to hold money as cash. If interest rates go up, there's more incentive to hold money in an interest-bearing form and less incentive to hold it as cash. This is his argument.

But Sumner is careful not to say "hold more of our money as cash."


If you wanted to show the relation on a graph, you'd want to show an interest rate. This, Sumner does. And you'd want to show the amount of cash people are holding, compared to money held in total. The ratio would show people's preference for holding money as cash. This, however, Sumner does not do.

Sumner's graph shows cash relative to GDP. The context variable is wrong. The graph does not show cash compared to money in total. The graph does not show what it must show to be relevant evidence.

The lines on Sumner's graph seem to support his statement about holding more cash, because the lines move in the directions they should move if his statement is true. But the blue line does not show the ratio that his statement describes.

Sumner's graph is not relevant evidence.


I pointed out the discrepancy on Sumner's blog:

Scott, why does your graph not show currency relative to *money* ?

You say that when interest rates fall, currency holdings rise. To my mind “currency holdings rise” is the same as “we hold more of our money as cash”. To look at “holding more of our money as cash” the graph would have to show currency relative to M1 or some broader money.

Sumner replied:

I use currency to NGDP, because I’m interested in explaining changes in NGDP, not the broader aggregates.

Of course he's interested in NGDP. The whole focus of his blog is NGDP targeting. That's fine. But it doesn't address the issue.

The ratio of currency to NGDP says nothing about the preference for holding money as currency. The ratio of currency to NGDP is not evidence of the desire to hold money as cash. Sumner's graph is not evidence of his claim. And his response to my comment does not resolve the matter.

Am I looking at this wrong? Or did Sumner try to bullshit me?


// Edit, 11 Jan 2019, changed
"More cash, compared to the money people hold in total, I think" to
"More cash, compared to the money people have in total, I think".
Now that I know what "holding" money means.

Working out the Components of Base Money (and pulling out my hair)

Following Jim's link

http://www.federalreserve.gov/releases/h3/current/default.htm

gets me to the H.3 release -- the current H.3 release, the link suggests. Here's what I get from it.

From Table 2 Footnote 1:
Total Reserves = Total Reserve Balances Maintained plus Vault Cash Used to Satisfy Reserves.

Matching up FRED values to Release H.3 values shows that
TOTRESNS is Total Reserves
RESBALNS is Total Reserve Balances Maintained
VAULT is Vault Cash Used to Satisfy Reserves

From Table 2 Footnote 5:
Monetary Base = Total Balances Maintained plus Currency in Circulation.

Matching the values shows that
BOGMBASE = Total Monetary Base
BOGMBBM = Total Balances Maintained

"Total Balances Maintained" and "Total Reserve Balances maintained" are different series with the same values expressed in different units.

MBCURRCIR = Currency in Circulation

The Notes on MBCURRCIR at FRED say that Currency in Circulation includes Vault Cash. As it is not specified as "vault cash used to satisfy reserves" I assume they mean total vault cash.
TLVAULT is total vault cash.
The values match up, confirming my assumption.

Okay. If you have money "in reserve" that money is not "in circulation". That's why "reserves" are separate from "currency in circulation".

However, some of the currency in circulation is in bank vaults. And most of that money is set aside, in reserve. So even though it counts as currency in circulation when you're counting currency, it also counts as reserves, or *is* reserves, when you need it to be reserves. It's messy.

It's reserves in the form of currency. And that does make sense, because banks need to keep currency in reserve, in case their customers need it.

Components

Stacked graphs, showing each component of the money measure as a percent of total.

Components of Base Money

Graph #1
Based on what I figured out after beating my head against the H.3 Release (link provided by Jim),

Base Money is composed of "balances" at the Fed and "currency in circulation". Balances are reserves, and currency in circulation ain't. Except that "vault cash" is included with currency in circulation, and the better part of vault cash is used to satisfy required reserves. The worse part of vault cash is called "surplus".
On the graph I split vault cash into its circulating and reserve components. This all gave me a headache.

Not sure why vault cash is used to satisfy required reserves, when there are trillions of dollars of excess reserves that could heva been used to satisfy required reserves instead.

Components of M1 money:

Graph #2
FRED: "M1 consists of: (1) currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions; (2) traveler's checks of nonbank issuers; (3) demand deposits; and (4) other checkable deposits (OCDs), which consist primarily of negotiable order of withdrawal (NOW) accounts at depository institutions and credit union share draft accounts."

Components of M2 money:

Graph #3
FRED: "M2 consists of M1 plus: (1) savings deposits (which include money market deposit accounts, or MMDAs); (2) small-denomination time deposits (time deposits in amounts of less than $100,000); and (3) balances in retail money market mutual funds (MMMFs)."

Components of MZM money:

Graph #4
FRED: "M2 less small-denomination time deposits plus institutional money funds."

I thought I would be able to find similar data on M3 at ALFRED. Silly me.

"There is one more thing I want to tell you, Ben," Greenspan said, "but I can't remember just now."

Broad money relative to narrow money. In this case, M2 relative to Base:

Graph #1: M2 Money as a Multiple of Base Money

M2 money hugged the "8" line -- 8 times the size of Base Money -- for eleven years, from June 1995 to June 2006. With one minor disruption for the Y2K thing. Eleven years, eight times base. Even during the dot-com bubble and the 2001 recession.

There's no way that wasn't policy.

After the 11-year flat spot, the ratio started going up.

Ben Bernanke took the helm in February 2006. The ratio started going up in mid-2006 and stopped less than two years later.

Oops.

FRED® Graphs ©Federal Reserve Bank of St. Louis. . All rights reserved. All FRED® Graphs appear courtesy of Federal Reserve Bank of St. Louis. http://research.stlouisfed.org/fred2/

Holy crap. Did you see this thing?

I read it. But I don't know if I understand it or not. I'm no lawyer.

I put the copyright statement they require down at the bottom of the page.

Holy crap.

Third time's the charm

This morning I clicked the link for this graph from mine of the 12th

Graph #1: RGDP Relative to Base Money, 1947-2015

to see the FRED source page. I clicked MAX to make the graph show all the data, and I notice a change at the right end, the recent end. Maybe an update? Okay.

I zoomed in on the graph to see it:

Graph #2: A Detail from the Recent End of Graph #1

Hovering over that thing at FRED, it turns out there is a slight uptick at the end. Too slight to see, obviously. The value goes from 4.08915 at the next-to-last data point (2015 Q3) to 4.13085 at the last data point (2015 Q4). Like I said: slight.

But uptick is a big deal. On Graph #1 there, it's all one big uptick from 1947 to 1966, and that was a golden age. So I'm interested in what might be happening now.

I made a new graph showing RGDP and Base Money separately, the growth rate for each, quarterly, and zoomed in even more to get a good look:

Graph #3: Recent Growth Rates for RGDP (blue) and Base Money (red)

Why are the default colors so dull? No wonder they call economics the dismal science.

So, the uptick at the right end of Graph #2, we got that uptick not because RGDP growth went up, but because Base Money growth went down.

The red line is below zero there at the end. Base money shrank.

(Is that even a word?)

I'm staring at that graph in disbelief. I see the red line running downhill, driven downhill by policy. It reminds me of something:

Graph #4: Growth Rate of the Monetary Base

Maybe soon we'll add a third circle of Hell to this one.

2020 vision

Consumer debt:

Graph #1: Household Debt thru Third Quarter 2015

Caught my eye: debt is on the increase again. Looks like a good two years of consistent increase, after getting around that bottom.

Then I started wondering about the slope of that increase and how it compares to the slope of debt increase before the crisis. And when in the pre-crisis period did we have debt showing a similar slope?

I thought that was worth pursuing.

FRED's annual data goes back to 1945 -- that's new -- but quarterly data starts with 1951Q4. That's fine. I want quarterly.

Not sure how to figure "slope" for debt, because the x-axis units are time. What the heck. I'll look at two-year changes in consumer debt and divide by 8 to get a per-quarter change. Close enough.

The last data point for the series is $633.45 billion larger than the point two years earlier. That works out to $79.18 billion increase per quarter for those two years. That gives me a base line.

I figured all the years by the same calculation and put that on a graph along with the base line. The base line (red) shows how fast consumer debt increased in the last two years. The blue line shows the rate of debt increase average quarterly debt increase for two-year periods going back to the 1950s:

Graph #2: The rate of increase in Consumer Debt

The blue line almost touches the red in 1986Q4, and actually crosses it in 1995Q2. After 1986 debt dawdled downward till 1992, then started rising again. After 1995 debt growth leveled off for a bit, then started rising again in late 1998.

It might not be bad if debt growth leveled off again now. 1995, 96, 97, and 98 were pretty good years for us. Debt was already high then, of course, but...

Graph #3

... but debt is much higher now.

Still, one wonders... What if we were to pick up now with debt growth following the same path we saw for debt growth since 1995Q2? What would our future look like, then? Like this, perhaps?

Graph #4

That's probably best case, putting off the next crisis till the late 2020s.

A graph, some numbers, and a political standard

So I was cleaning up my desktop ...

I save everything to the desktop so it's easy to find. Then every so often I go and move files to archive locations. I was moving files, putting things in some kind of order and making space on the desktop for more, when I came upon this graph again:

Graph #1: RGDP relative to Base Money, 1947-2015

I like it. It shows real output growing faster than base money until 1966, and slower thereafter. What would cause such a change? Important question.

The graph compares RGDP (a measure of how well off we are) to the money measure managed by policymakers. Meaningful numbers.

The graph shows that our economy has grown more slowly than base money since 1966. Or, that since 1966 base money has grown more rapidly than the economy.

But which? I looked at the numbers.

Between 1947 and 1966, RGDP increased 117%. Base money increased 51%. Real output grew 2.3 times as fast as base.

Between 1966 and 2015, RGDP increased 291%. Base money increased 7802%. Base increased 26.8 times as fast as real output. Wow.

RGDP grew a lot more in the second period than in the first. But the second period is a lot longer. If you look at output growth per day, growth was 5% faster before 1966 than after.

Base money growth in the latter period is huge. A lot of that has to do with inflation of course. Printing money causes inflation ... or if prices go higher, you need more money to maintain a given level of economic activity ... or both. But it is certainly true that the faster rate of base money after 1966 did not make RGDP grow faster after 1966 than before.

One might wonder whether more restrained money growth in the latter period would have resulted in more restrained output growth. That would be my guess. But many people would likely say restrained base money growth would have resulted in improved output growth. We'll set that question aside for now.

Instead, let us consider the whole picture. What would have caused the ratio to turn from increase to decrease? What would have driven RGDP growth down? And what would have driven base growth up?

My answers are simple: Policy drove base growth up. And the economic environment drove RGDP growth down. Am I skirting the issue by not identifying the problematic elements of the economic environment? Surely you know by now my answer is that the problematic elements are excessive private sector debt and the policies that drove debt to excess. For me, it all comes down to policy.

And what about the economic environment? That's easy. If the economic environment is good, the government has successfully promoted the general welfare. If the economic environment is not good, policymakers have fumbled the ball.

For me, it all comes down to policy.

The Sweet Spot

Revised from mine of 21 November 2011, with updated graphs.

As evidence that "inflation is always and everywhere a monetary phenomenon", Milton Friedman offered graphs showing similarity between the level of prices and the ratio of money to output. But his output number had inflation stripped away, which made his money/output ratio top heavy with inflation. Being top heavy made the ratio look like the path of prices on his graphs. This was Milton Friedman's evidence.

In the real world, you can't strip rising prices from output. In the real world, when prices go up we're stuck paying higher prices. And in the real world, the money/output ratio looks nothing like the level of prices.

In Milton Friedman's world, the ratio always went up. In the real world, between 1946 and 1981, the ratio went down:

Graph #1, Showing the Money Available to Purchase the Output We Produce

Milton Friedman's graphs figure output at prices that never go up. His graphs seem to show that there was too much money to buy the output at those fantastic unchanging prices. My graph #1 shows that between 1946 and 1981 we had less and less money with which to pay the prices that were actually charged for the goods and services we call "output".

We had more than 45 cents of spending-money for each dollar's worth of output in 1946. We had less than 15 cents for each dollar's worth of output in 1981.


I  added inflation to the graph. The rate of inflation. To look for similarity, I scaled and shifted the CPI data: I multiplied by a number that made the height difference of the CPI about the same as the height difference of the money/output ratio, and then added a constant to slide the whole set of CPI numbers up and get them close to the M1/GDP numbers. My goal was to make the two lines close. I got them pretty close, on the left half of the graph. Not so close on the right half:

Graph #2: Spending-Money per Dollar of GDP (blue) and Inflation (red)

Look at the left half of Graph #2. Look at the inflationary peaks in the red line. Apart from the inflation of World War One, the peaks pretty well fall within the limit set by the blue line. As the blue line rises, the red inflation peaks also rise, to a high point just at the end of World War II. And after the war when the blue line falls, so also do the peaks of inflation.

But then on the right half of the graph, the lines don't match at all. Inflation flares up again and again in the 1960s and 1970s while the blue money/output ratio continues to fall. Inflation subsides in the 1980s and 1990s, after the blue line has stopped falling.

Inflation moderated when they stopped tightening money. Isn't that odd?

In the years after 1960 there is no similarity between inflation and the money-to-output ratio.

Before 1960, inflation rose and fell within the limits set by the ratio. But U.S. anti-inflation policy quit working around 1960. Since 1960, the relation between M1/GDP and inflation has been absent.

This failure, this loss of trend similarity on the graph, had a counterpart in the real world. The so-called "Great Inflation" occurred while the money/output ratio showed tightening in the 1960s and 1970s. Then, when the money/output ratio stopped getting tighter, inflation subsided.

This is evidence of an astonishing loss of policy effectiveness.


Why did inflation policy stop working? What caused the loss of trend similarity?

What changed? Our reliance on credit increased. To fight inflation, the Fed suppressed spending-money. To stimulate growth, Congress encouraged credit use. They suppressed the money and encouraged credit use, and our reliance on credit increased.

What changed? Policy suppressed the quantity of money. Policy encouraged the use of credit. We found ourselves using less money and more credit because of policy.

What changed? The thing we use for money changed. We started using credit for money.

The difference between money and credit is that credit is more costly than money. An economy that shifts from low reliance on credit to high reliance on credit finds itself with financial costs rising relative to other costs. It finds itself with interest costs rising relative to wages and profits. It finds itself with living standards squeezed and business growth below par. It finds that finance has become its growth industry.

An economy that shifts from a low reliance on credit to a high reliance on credit will see rising costs that are associated with the cost of interest. Costs that affect prices, associated with the cost of interest.

I added Moody's AAA Interest Rate to the graph, in green:

Graph #3: M1/GDP (blue), Inflation (red), Interest Rate (green)

I made the red and green lines similar by scaling the green line and shifting it up a bit. After 1960, the green and red are a very good match: Inflation and interest rates show similar patterns. Before 1960, there is little similarity.

Before 1960 blue and red show similarity. After 1960 green and red show similarity. Before 1960, money was our primary medium of exchange. After 1960, credit was our primary medium of exchange.


Before the early 1960s there was too much money in the economy (and not enough credit use). After the early 1960s there was too much credit use (and not enough money).

The early 1960s are the sweet spot.

This is policy guidance.

The early 1960s are the sweet spot.

Preview and download the Excel file containing the graphs and data

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UPDATE 19 Feb 2016
I put this post on Reddit in r/Economics
IslandEcon reposted it to r/badeconomics
Some discussion there. Useful.

In response to IslandEcon's five points ("The author seems puzzled")
I'd say that I interpret the facts differently than he does.
The ending of the "accord" in 1951 is not observable on my graphs. (so, I think it is not as significant as he says)
And IslandEcon seems to hold velocity in higher regard than its components -- NGDP and the Money Supply. I don't.

There's no soaring, Scott, and no four percent

Sumner sides with Beckworth and Ponnuru:

Read the whole article, it's great.

I find it very odd that Krugman would claim that real interest rates are a good indicator of whether Fed policy is effectively getting tighter. After all, real interest rates soared right after Lehman failed, to over 4%. And yet that dramatic increase is strangely missing from the Krugman post they link to:

I'd just add that if there were anything to this story, we should have seen a sharp increase in long-term real interest rates, as investors saw the Fed getting behind the disinflationary curve. Here's the real 10-year rate in the months leading up to Lehman:

Why did Krugman leave off that surge in real interest rates?

Wow, did Sumner catch Krugman pulling the wool? Did Krugman stop his graph short, just before interest rates soared? Ya gotta watch these guys all the time. Political hacks in sheep's clothing, every last one of 'm. Here, here's the whole data series:

Graph #2: Same Data Shown by Krugman and Sumner, Showing All the Years

No.

No, Krugman didn't leave out soaring interest rates. There's no "soaring" after Lehman. There is a very brief spike that reaches 3% and immediately drops back to where it was before Lehman, then continues to drop at a slower pace.

And the high point of that brief spike, the 4%, or rather, the 3% peak, that high point looks to be pretty much right in line with the path of interest rates during 2006 and the first nine months of 2007. The spike did not reach an extraordinary level, and had no duration.

It was a one-percentage-point increase, for crying out loud.


Sumner wants us to see the "soaring" real rate as evidence money was tight:

Why did Krugman leave off that surge in real interest rates? Perhaps because it would imply that money got really tight in late 2008 ...

Clearly, however, the spike created by the Lehman event was a reaction to the "shock" of that event. Clearly, the spike occurred after the Lehman event of September 15th.

Beckworth and Ponnuru write

Between late April and early October, the Fed kept the interest rate over which it has most direct control, the federal funds rate, at 2 percent... Market indicators of expected inflation fell sharply that summer, a sign that the economy was getting weaker and monetary policy tighter.

Scott Sumner wants us to believe that a brief, temporary spike that occurred after mid-September is evidence money was getting tight between late April and early October. I don't see it.


"After all," Sumner says, "real interest rates soared right after Lehman failed, to over 4%."

Soaring is like this:

What the full graph shows is more like this

followed immediately by this

Pretty obvious on the graph, when you actually get to see it. No, you're right, Krugman didn't show it. But Sumner is the one who pointed it out. And Sumner didn't show it either. That's sloppy work.

Or maybe not so sloppy. If it's not on the graph and you claim that it is, then it's pretty smart to not show that graph. Smart fellow, Sumner.

Sloppy work or purposeful omission? I'm sure I don't know. I do know this: When you write about a graph you have to stop writing and get the graph and put it there in front of you and look at it while you write. Otherwise imagination takes over. Stories get invented. Wool gets pulled.

What is the relation between GDP growth and base money growth?

A few days back I showed this graph:

Graph #1: Growth Rate of the Monetary Base

Shows two unusually long periods of slowing money growth. The extended slowing was followed in one case by the Great Depression, and in the other by the Great Recession.

Each time, after the crisis hit, there was a period of exceptionally rapid money growth, as if policymakers understood that slow money growth had caused the problem, and that rapid money growth was the cure.

I think Graph #1 shows something extremely important.


In comments on the graph, Oilfield Trash said

I do not understand how one can simply look at change in stock and determine that is bad for GDP, with out looking at the velocity of the monetary stock ...

Good point. There certainly seems to be some relation between an extended period of slowing money growth and economic calamity. But I'm not prepared to say what that relation is. So Oilfield's observation is useful.

What is the relation between GDP growth and base money growth?

Graph #2: Growth Rates of Base Money (blue) and Real GDP, 1990-2008

Base money (blue) shows persistently falling growth from September 2001 to the crisis.

The growth of real output increases from 2001 to 2004, then turns downward and runs parallel to base money growth. As if the decline in money caused the decline in economic growth.

That shouldn't be surprising; it's how monetary policy is supposed to work.

I took the same two data series, base money and inflation-adjusted GDP, and looked at the RGDP-to-Base ratio to get an additional perspective on the relation between the two series. This one runs from 1947 to 2015:

Graph #3: RGDP Relative to Base Money, 1947-2015

Oh! I love it when a graph shows very few distinct trends. Increase, from 1947 to 1966. Decrease then, quite rapid till about 1994, slower thereafter, and becoming very flat for several years before the crisis. Those particularly flat years are 2004 to 2008, same as in the red circled area on Graph #2.

The line runs suddenly downward, near vertical, late in 2008, and continues to drift downward since.

Before 1966, Real GDP grew faster than base money. In other words, it was not loose money in the early 1960s that created the Great Inflation of 1965-1984.

Since 1966, Real GDP grew more slowly than base money -- both during and after the Great Inflation. There is no particular disturbance visible on the graph that would suggest Paul Volcker quashed inflation by manipulating the money. Unless... unless there was a link between RGDP and base money that caused them to move in sync.

The flat spot of 2004-2008 is flat and low. It gives the appearance -- indeed, the whole downtrend since 1966 gives the appearance of resistance to the downward movement. The line flattens over time. Until 2008, of course, when the economy suffered major damage, from which it has not yet recovered.

Please, not different wrong things, but right things

Syll links to the BBC's Economic Rebellion where we read

Since the crash of 2008, university students around the world have been rebelling against how they are taught economics... Economics teaching, say its detractors, is too narrow, too focused on mathematical modelling and without real world applications.

The problem is not that students are being taught the wrong things. The problem is that teachers don't know the right things.

The classical theorists resemble Euclidean geometers in a non-Euclidean world who, discovering that in experience straight lines apparently parallel often meet, rebuke the lines for not keeping straight as the only remedy for the unfortunate collisions which are occurring. Yet, in truth, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required today in economics.

Something similar is required today in economics.

Velocity or inequality?

I'm pretty sure a lot of the disagreement between people, when it comes to economic discussions, arises because we are talking about different economies. I generally talk about the one that produces GDP. And I generally see financial activity as a parasite on the economy like heartworms on a dog.

Many people, like Scott Sumner, I think, generally talk about the financial economy: I talk about the medium of exchange. Sumner talks about the medium of account.

The trouble with Scott's view is that finance is a parasite. The productive economy is the host. The parasite cannot live without the host. Left unchecked, the parasite kills the host.


Scott Sumner:

Interest rates are the opportunity cost of holding cash. If you lower interest rates, people will choose to hold more cash.

What people are those?

Sumner says velocity follows the interest rate because when the interest rate goes down, people hang on to more of their cash. And when the interest rate goes up, well, I guess when the interest rate goes up they switch out of cash and into forms of money that pay interest.

For that to be true, you have to be looking at people who have money they can choose to hang on to. I'm not among those people. Most people are not those people. Most people struggle to get by, clip coupons, get extra miles out of worn tires, and have little or no savings.

It's an inequality thing. A few people have most of the money. Most of us have little. Who are the people that hold on to their cash when interest rates go down? The ones who can afford it.

Idle money, idle chatter

Graph #1: M1 Velocity (blue) and the FedFunds Rate (red)

If you go to FRED and look at M1V it doesn't look like the blue line on Graph #1 here. Here, the blue line uses M1 with "sweeps" added back in. "Sweeps" is the money banks take out of your checking account at night while you're sleeping and use it to make themselves money. The M1V you'll find at FRED is figured while you're sleeping, when the banks have that money out and the M1 number is low.

I guess they figure M1 is the money we spend, and we won't be spending while we sleep, so that money really shouldn't be in M1 anyway. I don't know what they figure. But if I have $100 in my checking account in the daytime, unspent, I expect to have $100 in my account while I sleep.

Anyway, the blue line here is based on the higher M1 number, the one that includes "sweeps". So the blue M1 Velocity line is different from what FRED shows.

Actually I don't like thinking of it as velocity. I think of it as GDP relative to the money we have for spending. Usually I do that ratio other side up: the money we have for spending relative to the stuff we buy with that money. Stuff = GDP. Goods and services. You know the drill.

When you look at it as the money we have for spending relative to the stuff we buy with that money, you can see if we have a lot of money in the economy, or little money in the economy. And actually, you can see the changes from lot to little. To me that's meaningful. When we have a lot of money the streets are paved with gold. When we have little, times are hard.

But economists don't look at it that way. They turn the ratio other side up, as it is on the graph above. This way we get to look at how much GDP we bought with each dollar we have. We bought about $5 of stuff with each dollar in the late 1960s. Then it went up, and we bought about $7.50 of stuff with each dollar in the early 1980s. Then it drifted down to about $6.50 of stuff by the time of the crisis. After that, quantitative easing increased the M1 number, and the blue line ends up about where it started.

I don't really find that useful information. Economists say we were spending money faster. I think that's bullshit. We were using more credit and accumulating more debt. Oh, but they can't say that, because they say debt doesn't matter. They say our debt doesn't matter. As opposed to the Federal debt.

You really shouldn't spend a lot of time listening to what economists say.

Anyway, the graph. Velocity went up regularly before 1981 while interest rates were spastic from the inflation of the time. But since 1981 the red and blue lines move together. Really quite remarkably together, I think.

Oh, and you see there at the end, after 2010, the blue line goes down a lot but the red line runs flat. The red line runs flat because that's the interest rate at the zero bound, where it won't go lower. Some economists say interest rates should have gone down below zero. You could see that. The red line would continue to run parallel to the blue, and interest rates would end up below zero. Other economists dispute that.

It's all idle chatter.

The Fiscal Policy of Emperor Constantine

From Inflation and the Fall of the Roman Empire, a transcript of Prof. Joseph Peden's 50-minute lecture. By way of Vincent Cate.

The next emperor who interfered with the coinage in a meaningful way was to be Constantine, the first Christian emperor of Rome. Constantine in the year 312, which is also the year he issued the Edict of Toleration for Christianity, issued a new gold piece which he called by a new name, the solidus — solid gold. This was struck at 72 to the pound, so it was in fact debased over Diocletian's. These were very large issues and historians have puzzled over where he got all the gold; but I think the puzzle is not so much of a real puzzle once you begin to look at the legislation that took place.

First of all, he issued two new taxes: one was taxed on the estates of the senators, and this was rather new because senators generally were free of most taxes on their land. He also issued a tax on the capital of merchants; not their earnings, but their capital.