Thursday, December 15, 2016

When deficits started going up, and locating the base year

Did a couple quick searches -- seeking how to adjust debt for inflation and then national debt adjusted for inflation by president. Five sites caught my eye. First, an oldie from 2008 -- U.S. Public Debt Since 1940 - Adjusted for Inflation at Economic Perspectives:
Adjusting the public debt for inflation provides a good account of federal government borrowing. The public debt increased in the 1940s to finance World War II. The public debt remained fairly constant from the late 1940s through 1981. This means the U.S. was reasonably responsible with its finances, collecting sufficient revenues to pay for government services...
The first four sentences present us with an introduction, two observations, and a conclusion. That conclusion:

The U.S. was reasonably responsible with its finances before 1981, collecting sufficient revenues to pay for government services.

But was it? According to Christina Romer, "The 1960s introduced Americans to the phenomenon of persistent peacetime deficits." That's the '60s, not the '80s.

Here's what FRED has to say about deficits, on a bar graph, flipped to show deficits above zero and surpluses below:

Graph #2: Federal Deficits, 1945-1992
Just by eye, there are more and bigger deficits in the 1960s than in the 1950s.

Obviously, deficits were bigger in the 1980s than in the 1960s. That's not the question. The question is what happened before the big deficits were obvious. What happened when trouble was still only a-brewin', in the years before the fit hit the shan. That's the question.

I brought the data from Graph #2 into Excel and put trend lines on it. There's a curved blue trend line that describes the whole period from 1945 to 1992. And there's a straight red trend line that describes only the years from 1950 through 1969:

Graph #3: Deficits and Trend, 1945-1992 (blue) and 1950-1969 (red)
Obviously deficits were bigger in the 1980s than in the 1950s and '60s. Bigger in the wartime '40s, too. The 1950s and '60s were a relative low in Federal deficits. It's right there on the graph. I can see it.

But the red trend line should make it obvious that deficits were trending upward even in the 1950s and '60s. Can you see it? I say "should" make it obvious, because if you don't want to see it, you won't see it no matter how obvious it is.

Even the blue shows the trend of deficits rising since 1960. It shows deficits falling after World War Two, and rising since 1960. The red line tells us deficits started rising in the '50s, so I guess they stopped falling in the '40s.

Federal deficits were increasing since the 1950s. Deal with it.


Back at FRED, I found a price deflator for Federal spending. I took Graph #2, changed it from a bar graph to a line graph, put the same data on the graph a second time, this time in red, and used the price deflator to take inflation out of the red one:

Graph #4: Federal Deficits (blue) and Inflation-Adjusted Federal Deficits, Base Year 2009 (red)
The red line rises more steeply than the blue, and the numbers are bigger.

Bigger? Yes. Removing inflation makes these numbers bigger. Years back, a dollar was worth more than it is today. $100 back then was worth more than $100 today. So if we show it on a graph -- in today's dollars -- the value of $100 back then has to be more than $100. That's why the red line is higher than the blue.

I know, it sounds like doubletalk. That's because economists insist on using a recent year (like 2009) for the base year. If we used the first year on a graph for the base year, inflation would make the numbers bigger. And removing inflation would make the numbers smaller. And it would all make sense.

When we take a recent year like 2009 for the base year and look backward in time from there, removing inflation makes the numbers bigger. It sounds like doubletalk because we have to look backward in time when we look at years before the base year. We have to think backwards to make sense of it. That's hard to do. I don't want to do it. I want the first year to be the base year.

Bear with me here. To remove the effects of inflation from a number, you just divide it by a price index number. The price index data is a set of numbers that go up following the same path as prices. Doing the division takes the inflation out of each year's deficit number. Or, out of nominal GDP if you are working with nominal GDP.

When you do the division and take out the inflation, the deflated numbers are smaller than the original numbers. BUT THAT'S ONLY TRUE IF YOU ARE GOING FORWARD IN TIME. If you are going backward in time from the base year the deflated numbers are BIGGER than the originals, like on Graph #4. It's a friggin mess, and the whole mess exists only because economists insist on using a recent year for the base year, so that most of the years require you to think backward.

Screw that.

They typically give the base year the value 100. For example the Federal spending price deflator I used on Graph #4 tells me "2009=100". So after I do the division and eliminate the inflation, I have to multiply each number by 100. This makes all the adjusted numbers bigger while keeping them in proportion.

It also makes the adjusted base-year number equal to the original base-year number. That's why you always see real and nominal GDP lines crossing in 2009. And if they cross in 2005 instead, it tells you that the base year of the price index must be 2005. That would be an older price index and probably an older graph.

But anyway, it's dividing by the price index that removes the effects of inflation. And it's multiplying by the base year value (typically 100) that brings the adjusted numbers up near the original numbers.

After that long and painful explanation, for which I apologize, I can get to the point: We don't have to multiply by 100. We can multiply by some other year's value. If we have "2009=100" and we multiply by 100, the adjusted numbers are "2009 dollars" and the lines will cross at 2009.

But if the price index value for 1945 is 7.736, you can multiply by 7.736 instead of by 100. Multiplying by the number for 1945 makes 1945 the base year. The adjusted numbers are "1945 dollars". On your graph the lines will cross in 1945. And if there is inflation in the years after 1945, you will see the original (inflating) line get higher, as you would expect. And the adjusted line, with inflation removed, runs low. Here's an example:

Graph #5: Federal Deficits (blue) and Deficits with Inflation Removed (red), Base Year 1945
Looking forward from 1945, this graph shows the blue line (inflated values) higher than the red line (inflation stripped away).

On Graph #4, looking backward from 2009, the blue line (inflated values) is lower than the line that shows no inflation. It doesn't make sense to show inflated values lower. The arithmetic is right on #4. What's wrong is the whole idea of using a base year that is not at the start of the graph.

Graph #5 shows inflating deficits (blue) higher and rising faster than inflation-adjusted deficits, as you would expect to see because of inflation, and not at all like Graph #4.

On #5 you can see that the red and blue lines run pretty close together until the mid-60s. This agrees with what we know, that "the Great Inflation" didn't start until around 1965.

The space between the red line and the zero line shows the size of the deficits without inflation. The space between the red line and the blue line is all inflation. You should look at Graph #5 and say "Wow".

But because the blue line goes up so high, the red line is squashed down near the zero line. This makes it look like the Federal deficits were small and didn't increase much. But it only looks that way because the red line is squashed down so much by the presence of the blue line. I can fix that by removing the blue line:

Graph #6: Inflation-Adjusted Federal Deficits, Base Year 1945
Before 1960 (and after the World War Two adjustment) the deficits are pretty well centered on the zero line. During the 1960s, the deficits are almost completely above the zero line. During the 1970s the deficits are clearly above the zero line and noticeably higher than in the 1960s. And during the 1980s the deficits are noticeably higher than in the 1970s.

The inflation-adjusted Federal debt is equal to the sum of these deficits. Would it be right, do you think, to say "The U.S. was reasonably responsible with its finances before 1981, collecting sufficient revenues to pay for government services"? I don't see it, myself. I see a gradual and persistent increase in deficits since the 1950s.

Whether this has anything to do with being "responsible" is not an economic question.

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