The Lucky Number

I thought I'd like Larry Summers' A world stumped by stubbornly low inflation. But he opens with six "Imagine this is happening now" paragraphs, one after the other, followed by a "Finally, suppose this is happening too." He coulda just said "Suppose all the signs were pointing to strong increase in inflation" and been done with it. But no.

Then Summers says things actually are that bad, but in the opposite direction. He says inflation is refusing to go up.

I still think it's odd when economists call for more inflation. It shows how really bad the economy is -- and how really bad the economists are.


Summers also says this:

In the 1970s it took years for policymakers to recognise how far behind the curve they were on inflation and to make strong policy adjustments.

Policymakers continued to worry about a supposed lack of demand long after it was an important problem. The first attempts to contain inflation were too timid to be effective and success was achieved only with highly determined policy. A crucial step was the abandonment of the idea that the problem was structural in nature rather than driven by macroeconomic policy.

Oh, I read about that. Marcus Nunes covered the main points almost four years ago in A last ditch defense of Inflation Targeting -- a post I still turn to for its historical perspective.

1. Summers says "In the 1970s it took years..."

Inflation was already a problem in the 1960s. But Paul Volcker, credited with ending inflation, did not take charge at the Federal Reserve until 1979.

2. Summers says "The first attempts to contain inflation were too timid..."

Marcus Nunes quotes Roger Farmer: "After 1983, the inflation-reaction coefficient increased; the Fed raised the short-rate by a larger percentage in response to inflation than it had done in the period from 1951 through 1979."

According to Nunes,

Roger Farmer´s statement is consistent with the “consensus view”, held, among others, by John Taylor (for obvious reasons) and Bernanke himself.

Consistent also with the view of Larry Summers, it seems to me.

3. Summers says "A crucial step was the abandonment of the idea that the problem was structural in nature rather than driven by macroeconomic policy."

Marcus Nunes describes the "structural" idea: "According to Robert Hetzel, during the period of the Great Inflation, the prevailing view, and the one embraced by Arthur Burns, Fed chairman from 1970 to 1977, was that inflation was a real (cost-push), and therefore non-monetary, phenomenon."

But this was no longer the prevailing view after 1983.


The Arthurian view is that the inflation was indeed cost-push. However, the initial inflationary push did not come from "excessive wage increases" as Arthur Burns thought. Rather, rising financial costs provided the initial push in the early 1960s. Possibly earlier.

Initially, rising prices and higher wage demands arose in response to the "push" of rising financial costs embedded in products and payments throughout the economy.

Graph #1: Interest Paid by Corporations as a Multiple of Corporate Profits Before Tax

Graph #2: Interest Paid by Households as a Percent of Employee Compensation

These days, people seem to think having a lot of private debt is normal. It is, but only because the economy has been so bad for so long.

Instead of having as little exogenous (government issue) money as possible, and stretching it with endogenous (bank issue) money until the economy fails ... instead of that, all we need is to pick a number. Pick a number for the endogenous-to-exogenous ratio. Look for a number that gives optimum economic performance: a lucky number. The number we have now is way too high: We have too much endogenous money (and too much private debt) relative to exogenous money.

We want to keep exogenous money up around a certain percent of GDP, and we want to keep endogenous money down to a certain multiple of exogenous. That's the plan. Pick a number.

Look at the economy and say We need this much money in total. Then use the lucky number to figure how much of the total should be government-issue, and how much should be bank-issue money.

We may need more government-issue money than we have today, and less bank-issue. Creating more government-issue could help to solve a lot of the problems in our economy. Reducing bank-issue will require some fiscal incentives to accelerate the repayment of debt.

The lucky number: a ratio of broad money to narrow, kept by policy in the range that best suits economic growth.

// see also: The Sweet Spot