Friday, March 18, 2016

Something interesting this way comes

Suppose we take this graph of the short-term interest rate and the calculation that makes a pretty good simulation of it for eighty years or more --

Graph #1: The Interest Rate (blue) and the Result of Calculation (red)
Suppose we take that graph and get rid of the interesting part. We're left with a picture of the quantity of base money, relative to NGDP. It reaches a low point in 1981:

Graph #2: Base Money relative to NGDP
There is an interesting increase in the recent years. I want to get rid of that.

Oh -- but you know, the line reaches a local maximum in 2003 and then goes down till 2007. That downsloping dingus may or may not have caused the crisis and led to the big increase of the recent years. That's interesting, huh? Let's get rid of the dingus, too.

That leaves us with a line that ends in 2003. That's 22 years after the 1981 low.

Now I want to go back 22 years before the low, back to 1959, and I want to cut off all the interesting stuff that happened before then. This gives me a graph of Base to NGDP for the period from 1959 to 2003, with a low point right in the middle:

Graph #3: Base Money relative to NGDP, 1959-2003
Nothing interesting here. I changed the line color to blue to liven things up.

I'm wondering what the activity was, that caused the change in the blue line, first running downhill, then up. Thought I'd take a look at the growth rates of NGDP and Base Money.

Graph #4: M/PY (blue), Base Money Growth (red), and NGDP Growth (green)
For the blue line we have the label "M/PY". That's left over from the Hussman Funds interest rate calculation I got from Oilfield Trash the other day. The "M" stands for "Money", here Base Money. The "PY" stands for "Price times Output". You can think of Price as the GDP Deflator, and Output as RGDP, and RGDP as GDP with the price changes stripped away, GDP being the same as NGDP. Or you can think about more interesting things.

On the graph, in the years before 1981, when the blue line is going down, the green line is consistently higher than the red. Before 1981, NGDP growth is consistently higher than base money growth. That's why the blue line goes down.

After 1981, the red line is generally higher than the green. Base money growth is generally higher than NGDP growth. That's why the blue line goes up.

Okay, so the blue line tells us that NGDP grew faster than Base for the period before 1981, and Base grew faster than NGDP for the period after 1981. That's a fact. Taking it as a fact, now I have a question or two.

How come we had inflation before 1981, but not so much after 1981? How come it was said they were printing too much money (and this was causing the inflation) before 1981, when base money growth was relatively slow? And, how come we didn't get inflation after 1981, when base money growth was relatively fast?

There must be something wrong with the inflation story they tell.

Now, that is interesting.


Oilfield Trash said...


The answer is somewhere in here, and the fact the US dollars has worldwide reserve status.

It is much easier for countries to grow if they run trade surpluses. This is not because exports create growth, but because inflows of FX reserves act as a monetary stimulus: the risk, of course, is inflation.

Conversely, trade deficits involve a net outflow of FX reserves, which is monetary tightening. There is thus a direct relationship between domestic growth, domestic inflation and the external balance.

P*Q=M*V Monetary policy should be view as a mop up activity after all the economic collisions take place. If FED Policy is framed as one that steers the economy to avoid economic collisions it is no wonder everyone thinks they do a horrible job at avoiding train wrecks.

The Arthurian said...

Oilfield Trash: "inflows of FX reserves act as a monetary stimulus"

Okay, that's brilliant. And it follows that "a net outflow of FX reserves ... is monetary tightening."

(But I will have to look at NETTFI for a while to see if I can accept this idea.)

So, how does this all relate to inflation before and after 1981? Are you saying that after '81 the Fed had to increase base money at a faster rate because of the "net outflow of FX reserves" ??

And then, before 1981 the story would be that base money increased slowly, but not slowly enough? That would agree with Anasthsios Orphanides, quoted by Marcus Nunes:
"If anything, the policy mistake of the late 1960s and 1970s is that actual monetary policy followed the Taylor rule, too closely! Rather than follow the Taylor rule, policy should have been considerably tighter."

But that goes against everything I have discovered for myself, and I do not buy the "policy should have been tighter" story.

My view is that the rising cost of finance in the US economy all thru the 1960s and after made US products uncompetitive in international markets, and that this is the original source of the US trade deficit. The trade deficit would still have the monetary effects that you describe, but these would be consequences or contributing causes, not original driving forces.

For me it follows that reducing US costs by reducing financial costs would help to reduce the trade imbalance...

I think I went off topic and got lost :(