Remembering

Two posts back I said Marcus Nunes was concerned that people would accept the new, lower trend of economic growth and forget the higher trend of the eighties and nineties and naughts. "Forget" was my word. Maybe it wasn't quite right.

But Marcus does say "there´s a wide acceptance of the new trend." People are giving up on trying to get back to that old, high trend. Maybe the word "forget" is not so far off, after all.


In that post I used Marcus's graph, which goes back to the late 1980s and shows the high trend and the low trend, both. My post also quoted Menzie Chinn talking about a trend based on the 1984-2007 period and saying this trend now seems implausibly high. Chinn wants us to forget about the high trend.


I find it interesting that Marcus and Menzie both show the old trend existing since the 1980s. Interesting, because for a long time it was widely recognized that there was an economic slowdown in the mid-1970s, from which we never fully recovered. The older trend, from before the mid-1970s, was even higher than the old trend that Marcus and Menzie show.

Evidently, the older trend is even more completely forgotten. "Abandoned" might be the better word. Let's have a look.


FRED provides the Real GDP data series GDPC1. Menzie Chinn provides the range of dates used to establish the trend. Excel provides an exponential trend line and the trendline equation:

Graph #1: Real GDP (blue) and the Exponential Trend (red) for 1984 to 2007

Showing an exponent of approximately 0.0313, the equation indicates average annual growth of about 3.13% for the 1984-2007 period.

I used the trendline equation to calculate values for the 1984-2007 trend, to extend the trend from 1947 to 2016. Then I showed those values as a red line on a new graph, along with Real GDP. By this method we can see how well the 1984-2007 trend fits the RGDP data for the full 1947-2016 period:

Graph #2: Real GDP (blue) and the 1984-2007 Trend (red) in the 1947-2016 Period

It appears to be a good fit, right up to the problems of 2008. Then Real GDP falls away from the trend and establishes the new, lower trend, as discussed by Marcus Nunes, Menzie Chinn, and others. Even before the 1980s the fit looks good, in the 1970s, and in the late 1960s.

Before about 1965, Real GDP (blue) does run persistently below the 1984-2007 trend (red). It doesn't appear to be off by much. One good way to tell how much it is off is to show a trend line based on those early years on the graph.

According to what Scott Sumner said ("growth in US living standards slowed after 1973"), Ross Perot's graph in yesterday's post, and the observations of others, 1973 seemed to be a good end-date for the early years' trend.

Then, for the start-date, I remembered Marcus telling me he likes to omit the years before 1952 "to avoid the post war adjustment which distorts the data." I like to imitate what I see economists doing, so I went with the 1952 start-date.

This next graph shows the same Real GDP (blue) and the same trend line based on the years 1984-2007 (red) as the graph above. But to gauge the difference visible in the years before 1965, this graph adds an exponential trend line (black) based on the years 1952 to 1973:

Graph #3: RGDP (blue), the 1984-2007 Trend (red), and the 1952-1973 Trend (black)

In the early years, there is not much difference between the trends. But there is a huge difference by the end. Menzie Chinn's 1984-2007 trend brings Real GDP to 20 trillion dollars by 2016. The 1952-1973 trend brings Real GDP to 30 trillion. And Menzie thought the lower of those numbers was an "implausible" outcome!

But what if these are not implausible outcomes?

// The Excel file

The previous slowdown in economic growth

Arguing with Paul Krugman, Scott Summner wrote: "I am not denying that growth in US living standards slowed after 1973, rather I am arguing that it would have slowed more had we not reformed our economy."

Sumner accepts the view that the growth in US living standards slowed after 1973.

The classic graph that shows that slowdown is this one from Ross Perot:

Graph #1 Source: Ross Perot, United We Stand
(from when Perot was running for President in 1992)

Before 1973, living standards would double in less than two generations. After 1973 it would take 12 generations for living standards to double.

If a generation is 25 years: Before 1973 it took less than 50 years for living standards to double. After 1973, according to the graph, 300 years.

Scott Sumner says things would have been even worse if not for the Reagan-era reforms.

Perot lost the 1992 election to Bill Clinton, and during the Clinton years the economy improved. (I'm talking chronology here, not causality.)  The "generations required" number came back down, but only for about ten years. Then it went up again. And after that we had the financial crisis and recession, and the "generations required" went up even more.

Skipping a stone across recent years

Early 2008, not long before the 2009 recession: Real GDP (blue) is right on track, and the track itself (Potential GDP, gray) is predicted to continue rising, undisturbed, for a decade:

Splash #1

Early 2010: In the past two years there was a recession (vertical gray bar). Real GDP (blue) dropped significantly, then turned upward again. In addition, Real GDP has been revised and now uses "2005 Dollars" rather than "2000 Dollars". 2005 Dollars are worth somewhat less than 2000 Dollars. It takes more of them to buy a given amount of Real GDP. That makes the blue line higher:

Splash #2a

For purposes of comparison, the above graph shows the "track" (Potential GDP, gray) as it was in early 2008. In point of fact, Potential GDP was also revised to use 2005 Dollars and, like Real GDP, is higher than it was before the revision:

Splash #2b

With blue and gray both revised, blue still appears to follow gray about as closely as it did before the revision, except since the 2009 recession. Also, for the future, gray appears to fall slightly below the path predicted in the previous graph, then return to it.


Late 2010: Ezra Klein examines the gap created by the 2009 recession. He looks at ways to to bring output back up to trend: Real GDP could accelerate quickly, or slowly, or not at all.

Splash #3

Early 2012: Pursuing Ezra Klein's third option, Real GDP (blue) continues on its new, lower path. Meanwhile, expectations have been somewhat reduced: The old 2010 trend (gray) has been lowered for 2012 (red):

Splash #4

In February John Taylor shows two graphs of recession and aftermath. One graph considers the 1982 recession, after which the recovery was like Ezra Klein's "rapid acceleration" model. The other considers the 2009 recession, after which the recovery is like the "no acceleration" model. But Taylor's graphs are not models. They are actuals.

That same month, James Bullard (PDF, 6 pages) offers a story to explain why we have a "no acceleration" recovery. In the years before 2008 our economy was in a bubble, he says. And the path predicted for our economy (gray, on Graph #1 here) was based on the bubble.

Imagine our economy without that bubble, Bullard says: predict a future path based on that lesser economic performance, and you will have a better prediction. In other words: Forget the Ezra Klein graph. We're not going to bring Real GDP up to trend. We're going to bring the trend down to meet Real GDP.

As I write this today (2017) Bullard's story seems reasonable, even to me. Bullard's is now the accepted story. How did we get here?


Late 2012: Scott Sumner says if the new (lower) trend continues he will "throw in the towel" and accept it:

In 2009 I advocated going all the way back to the old trend line. I currently favor going about 1/3 of the way back. If we keep on the same track for a few more years I’ll through in the towel and advocate starting a new 5% trend line from where we are.

Sumner, struggling to accept the lower trend.


2014: Marcus Nunes shows a graph of Real GDP since the 1980s, including the 2009 recession and the slower growth since that time. The graph also shows the old and new trends of Real GDP growth:

Splash #5

"For RGDP the trend growth rate is 3.3%," Nunes says. But "There´s no doubt that the economy was 'shifted down' during what has become known as the 'Great Recession', and it looks as if this shift is 'permanent'."

Yes, when the economy falls below trend, it is reasonable to assume that it will rebound back to it. The only thing is that the trend it will rebound to is the new much lower one. And that´s something that makes me think that there´s a wide acceptance of the new trend.

What this implies is that over time the “old trend” will, for all sorts of economic reasons, “cease to exist”, in fact coming down all the way to become one with the new trend level, in which the real economy grows at 2.2%...

Nunes worries that people will, like Sumner, forget about the old trend and accept the new one. There is wisdom in his words.


2016: “Is current output really 18% below potential output?” Menzie Chinn puts the question in quotes, suggesting he does not accept the 18% number. He explains:

One thing that should be remembered is that the trend line extrapolated from 1984-2007 implies that the output gap as of 2015Q4 is … -18%.

In other words, he says the 1984-2007 trend must be wrong. This graph, he says, "highlights the implausibility of the -18% output gap":

Splash #6

Menzie Chinn has turned a corner from Marcus Nunes. The old trend is unreasonable, Chinn says; therefore the new trend must be right.

His evidence? The long duration of the new, lower trend. Chinn enhances that duration by showing the new, lower prediction of Potential GDP, which conveniently aligns with the reported data. In fact, though, the new measure of Potential GDP is not better or more accurate than old measures of Potential GDP. Not better, only different. Lower.

And the duration of slower reported growth is not evidence that the old high trend was wrong. It may only be evidence that economists have not yet found the problem, and policy has not yet fixed it.

Marcus Nunes was right: The old trend has ceased to exist. People like Scott Sumner and Menzie Chinn no longer expect good growth to return. With their minds at last made up, economists can now go back to explaining the world making up their stories.

Time for another update already

Just to be sure

This graph (from yesterday's post) shows average growth rates for periods beginning in 1930. But the graph is a close-up. It only shows the years since 1952:

Graph #1

So the first point on the red line represents average growth for the 1930-1952 period. This seems misleading, as the years before 1952 are not shown. I want to re-do the calc, figuring average growth rates for the period beginning in 1952.

I'll keep the green line from the first graph, the "average annual growth" calculation from BEA. I'll toss the running average line, and make a new red line using the BEA calc on data from 1952 and after:

Graph #2

The new red line shows a lot of variation in the early years. That's to be expected, as there isn't much to average against. The green line has a backlog, 20 years of data from before 1952, acting like an anchor to prevent the green line from moving when the blue line moves.

In the early years the red line has no such backlog, so big changes in the blue line create big changes in the red. After a dozen years or so, the red has a backlog of its own. Then it is not so much influenced by changes in the blue. And then we see the red and green run side-by-side.

By the time the red and green run side-by-side, both are more influenced by their past than by each new change in the blue line. So if somebody says average RGDP growth in the 1947-2017 period is 3.21%, it tells us more about the past than it does about today.

On the other hand, if the side-by-side years show a general downward trend, it means there are so many below-average years that they are dragging the anchor down. I conclude, then, that the important information in these long-term averages is not that the average value is 3.21% or 3.3% or whatever.  The important information is that growth has been going downhill since the 1960s.


I go back to the first graph and this time keep the red line, the running average since 1930. I get rid of the green line and create a new one showing the running average since 1952. This time we compare running averages for two different start-dates.

Graph #3

This time the red line has an anchor, two decades of data from before 1952. The green line doesn't. So the green line responds more to changes in the blue than the red line does. But again, after a dozen years or so, the "since 1952" line has its own backlog, and we see red and green show the side-by-side behavior.

We get the same behavior for running averages as we got for the BEA calculation. It turns out that the "backlog" is more significant than the calculation that makes use of it. To me this says the long-run average isn't worth much, except it shows that new growth keeps dragging the average down.


To finish up, I'm replacing both lines on the first graph with the "since 1952" data.

Graph #4

Red and green follow the same path: decline since the 1960s.

// The Excel file

Decline of the long-run average

Today we look at long-run economic growth, and along the way compare the results of a running average calculation to a more complicated (but no doubt more accurate) calculation that the BEA uses to figure average annual growth.

The other day I read that the

GDP Growth Rate in the United States averaged 3.21 percent from 1947 until 2017

That reminded me of Marcus Nunes telling me

It´s more or less recognized that US RGDP is trend stationary (maybe that´s changed now!), with real growth averaging about 3.3% from the early 50s to 2007.

I'm not comfortable using averages that way. Compared to the economic growth of the last ten years, 3.21% average growth (1947-2017) seems quite high. And yet 3.21% is noticeably lower than Marcus's 3.3% for the period ending in 2007. It seems the more recent the end-date, the lower the average growth. I want to look at the numbers.

(Yes I know, the two long-term averages have different start-dates too. That's another reason I have to make my own graph!)

The first graph today shows Real GDP (annual data, faint gray, right-hand scale) along with annual growth rates (blue), an average of the growth rate values (red), and an average I got by using the BEA's "variant of the compound interest formula" (green):

Graph #1: On the right is where we have been recently. On the left is where we were before.

Both averages are figured for the full period to date. (The average for 1931 is based on the years 1930 and 1931; the average for 1975 is based on the years 1930 thru 1975; and the average for 2016 is based on the 1930-2016 period.) All the years since 1930 are included in each year's average.

I was happy to see there is not much difference between the red and green lines. No doubt the BEA's method is more accurate than a simple running average, but the running average looks like a good rough estimate. And the two lines seem to follow a similar path.

The blue line is up near 10% growth for a few years in the mid-1930s, and approaches 20% in the early 1940s. There are extreme lows before and after these extreme peaks. Then the next high after that has two dots a little below 10%. Those two dots represent 1950 and 1951. The second graph begins in 1952, and shows the same values as the first graph:

Graph #2: On the left is where we were before. On the right is where we have been recently.

Red and green run close together and show the same variations. Toward the right end, the green line is hidden behind the red, but both lines continue all the way to 2016.

Also, it is a little more obvious on this graph that average RGDP growth is in decline; red and green both show it. The averages ran at or above the 4% growth rate until 1980, then fell noticeably below the 4% rate.

Blue dots above the average pull the average up. Blue dots below the average pull the average down. The last blue dot above the average occurred in 2004.


//

The red and green lines never go as low as 3%. So for any year you pick, it wouldn't be wrong to say "The GDP growth rate in the United States averaged above 3.0 percent from 1952 until [year]". Sounds pretty good, right? Especially compared to the slow economy of recent years.

It is even true. But it is nonsense. Economic growth has been slowing. And the trend of growth has been slowing. The trend shows where the economy is going in the longer term.

You don't get a feel for where the economy is going when somebody says the average growth rate since 1947 is 3.21%. There were a lot of good years since 1947, that helped to bring the average up. That doesn't do us any good when we've been below the average for years. It's like you got an F on a test and your parents find out, and you tell them "Yeah, but the class average was a B!" That's not gonna help you.

And it doesn't give you a feel for where the economy is going when an economist says GDP is "trend stationary" at 3.3%. It doesn't even sound like things are going downhill. But they are.

// The Excel file

Comparing conclusions

From Time magazine, December 31, 1965

If the nation has economic problems, they are the problems of high employment, high growth and high hopes. As the U.S. enters what shapes up as the sixth straight year of expansion, its economic strategists confess rather cheerily that they have just about reached the outer limits of economic knowledge. They have proved that they can prod, goad and inspire a rich and free nation to climb to nearly full employment and unprecedented prosperity. The job of maintaining expansion without inflation will require not only their present skills but new ones as well. Perhaps the U.S. needs another, more modern Keynes to grapple with the growing pains, a specialist in keeping economies at a healthy high. But even if he comes along, he will have to build on what he learned from John Maynard Keynes.

 
From the Federal Reserve Bank of St. Louis Review, November/December 1998:

I am sure rigorous economic research of the kind Homer Jones advocated, directed, promoted, and carried out will be essential to developing and adopting policies to raise productivity growth and achieve such a goal. We need a new Homer Jones to help us find policies for economic growth just as we were lucky to have had the original Homer Jones to help us find policies for economic stability.

 

"More saving means more investment..."

John B. Taylor:

Simply running a budget surplus would help achieve the productivity growth goal. Why? Because by running a budget surplus, the federal government can add saving to the economy rather than subtract saving from the economy. More saving means more investment...

 
John M. Keynes:

Those who think in this way are ... are fallaciously supposing that there is a nexus which unites decisions to abstain from present consumption with decisions to provide for future consumption; whereas the motives which determine the latter are not linked in any simple way with the motives which determine the former.

 

Maybe I've been going about this all wrong

John Taylor explains a graph:

The trend line in Figure 1 shows where the economy is going in the longer term...
On the right is where we have been recently. On the left is where we were before.

It's like the commercial on TV that says "6 is greater than 1". Do people really need to be told such things?

Cycles

A list of economic cycles:

Source: Wikipedia

//

Off the top of my head, four cycles that didn't make the list:

   •  Short financial cycle (Borio) 16-20 years
   •  Long financial cycle (Greenspan) once-in-a-century
   •  Price waves (D.H. Fisher) 150-300 years, give or take
   •  Cycle of Civilization (Arthurian) 2000 years, give or take

//

Wikipedia's list indicates a "technological basis" for the Kondratieff wave.  Note, however, that Kondratieff found his cycle in prices [and interest rates]. Also, the Juglar cycle is referenced to "fixed investment". But as Yoshihisa points out in the IWATA PDF, "Conventionally, “Juglar Cycle” is attributed to the investment cycle. But his logic is mainly credit and speculation." So at least two of the four cycles listed have a monetary or financial basis. Plus all four of the ones I added to the list.

//

Eight cycles listed, total off the top of my head. Six of the eight are observed in or driven by or closely related to money or credit or finance. And that's just off the top of my head.

The road not taken

"Professor Commons, who has been one of the first to recognise the nature of the economic transition amidst the early stages of which we are now living, distinguishes three epochs," Keynes wrote in 1925, "three economic orders, upon the third of which we are entering."

The three epochs identified by Professor Commons are the Era of Scarcity, the Era of Abundance, and the Era of Stabilization. The change from the second epoch to the third, according to Keynes, is the source of some troubles.


Robert Skidelsky writes:

The classical economists of the nineteenth century looked forward to what they called a “stationary state,” when, in the words of John Stuart Mill, the life of “struggling to get on…trampling, crushing, elbowing, and treading on each other’s heels” would no longer be needed.

According to Skidelsky, the classical economists of the nineteenth century thought with Professor Commons that the world would move from abundance to stabilization. Skidelsky brings this up to make the point that secular stagnation (as described by Larry Summers) *IS* the stabilization, and we should get used to it: "one should view secular stagnation as an opportunity rather than a threat", Skidelsky says.


I say one should have doubts about any era of stabilization. The economy moves in waves and cycles. Growth follows recession follows growth. Why would this suddenly stop? Why would the economy suddenly "stabilize"? One day general equilibrium is unachievable, and the next day it is thrust upon us -- stable general equilibrium, no less. Hogwash.

It is unrealistic to think the world will stabilize. It is beyond ridiculous to think it will stabilize at an acceptable level of output. It is laughable to think it's all under control.

Can we make it happen? Possibly. But that is a different road than the one we have taken.

Asked whether there had ever been anything like the Great Depression before, John Maynard Keynes replied, "Yes, it was called the Dark Ages, and it lasted 400 years."

- Jon Meacham

The fall of Rome was a Great Depression on a grand scale. Professor Commons' "Era of Scarcity" was the long, slow recovery from that economic collapse. The "Era of Abundance" was the grand-scale boom. These are parts of a cycle, a business cycle on a grand scale: the cycle of civilization.

In place of the Era of Stabilization we can reasonably expect another grand-scale Depression, another "Fall of Rome", only this time it won't be Rome.

Can we avoid it? Possibly. But that is a different road than the one we have taken.

Now, as the final day of his campaign drew to a close, Scipio Africanus stood on a hillside watching Carthage burn. His face, streaked with the sweat and dirt of battle, glowed with the fire of the setting sun and the flames of the city, but no smile of triumph crossed his lips. No gleam of victory shone from his eyes.

Instead, as the Greek historian Polybius would later record, the Roman general "burst into tears, and stood long reflecting on the inevitable change which awaits cities, nations, and dynasties, one and all, as it does every one of us men."

In the fading light of that dying city, Scipio saw the end of Rome itself.

- Charles Colson in Against the Night

Arnold J. Toynbee identified at least 23 civilizations. Most of them are dead and gone. Toynbee, though, said the death of civilization was avoidable. Stefan Zenker lays it out:

In contrast to Oswald Spengler, who thought that the rise and fall of civilizations was as inevitable as the march of the seasons, Toynbee maintained that the fate of civilizations is determined by their response to the challenges facing them... The unifying theme of his book is challenge and response.

Challenge and response. If our response meets the challenge successfully, civilization advances. If not, civilization declines. It's that simple.

But we must choose the road less traveled. And that means that most of us have made the wrong choice.

Civilization

Civilization may be seen in the rise and fall of cities, but it is measured in the rise and fall of the standard of value.

A standard of value is not (as Investopedia describes it) a value. It is a standard -- a standard, like the dollar. Not "a" dollar, but "the" dollar. The dollar is not a value; it is a standard of value, as the inch is not a measurement but a standard of measurement.

Beyond that, the phrase "standard of value" encompasses the idea that it is possible to set such a standard. In this sense, then, when Charlemagne put us on silver, and 1200 years later when Nixon took us off gold, both relied on an economic environment that to varying degrees supported the concept of the standard of value.

For several hundred years before Charlemagne, the environment did not support a standard of value. And unless we are most judicious, we will before long discover that for several hundred years after Nixon the economic environment again does not support a standard of value. I know this because civilization is an economic cycle.

The usefulness of the cyclic view

Thinking in terms of the cycle helps to organize one's thoughts.

The idea, for example, that we should reduce government to something we can drown in a bathtub is part of the decline. So is the mindless alternative, that to solve the economy's problems we must make government bigger.

I have a few notes on the upswing of the cycle here and a detail on the downswing here.

If not the origins of money, then what?

If the important fact is not whether money first arose to replace barter, then what are the important facts?

   •  A cycle of civilization exists;
   •  it is an economic cycle, as is the business cycle;
   •  it can be observed in the rise and fall of money; and
   •  it is driven by the dispersion and accumulation of wealth.

The origins of money?

“I think it’s a mistake to think you’ll find the workings of modern money by going back to the origins of money.” -- Michael Beggs, quoted in The Myth of the Barter Economy

I agree with Beggs. But the article in which he is quoted, dwells on the origin of money not being barter. That's the least important thing.

"New rule #1: a 3 percent inflation target"

That's Thomas Palley's rule, a higher inflation target. Palley says

First and foremost, the Fed should raise its inflation target to 3 percent, or even as high as 5 percent. The current 2 percent target is a cap that inevitably keeps the economy in Wall Street’s bliss zone, and prevents the party from reaching Main Street.

I like Palley's "bliss zone" graph. But I don't see inflation as a solution to economic problems. When I took Econ 101 in the 1970s, the goal of policy was economic growth with price stability. If price stability is a goal, you don't get there by increasing the inflation target. And if the 2% target does not allow decent economic growth, then the proper response is not simply to raise the target. The proper response is to figure out why decent growth now requires higher inflation. In other words, the proper response is to figure out what the problem really is. Raising the target does nothing to discover that problem, and nothing to solve it.


Palley says raise the target. I want to look at that to see what the effect might be. And I want to look at inflation in relation to debt and GDP, for a few reasons:

1. Inflation changes GDP, but doesn't change debt.
2. Debt (private debt) is too high and must be reduced.
3. I want to see how Palley's plan affects debt and GDP.

I'll look at credit market debt relative to GDP (annual data) with inflation based on the GDP Deflator.

Palley says the inflation target should be 3% or maybe 5% instead of 2%. So, 1% higher than the target, or 3% higher than the target. But instead of imagining the future, I want to reimagine the past. I want to figure 1% higher (and 3% higher) inflation than we actually had in past years. I'll show higher inflation beginning in 1987, the year Alan Greenspan became Chairman of the Federal Reserve. I'll figure actual inflation, actual+1%, and actual+3%, and show all three together on a graph.

For debt I'm using FRED's TCMDO, which ends with 2015. So I'll be showing actual versus Palley-plan inflation for a period of almost 30 years. Maybe I should say: Palley proposes a higher inflation target for the future, not for the past. I'm just looking at the past because the data is available, to get a feel for how the Palley-plan future would turn out.


First off, GDP.  The blue line shows actual GDP (which is often called "nominal" GDP). The red line shows that same GDP and, since 1987, 1% per year more inflation than we actually had. That's the Palley 3% plan, where 3% equals target plus 1%. The green line shows GDP with 3% more inflation since 1987, the Palley 5% plan.

Graph #1

 The orange line shows GDP with all inflation removed. (This is often called "real" GDP.)  Usually, this line crosses the blue line in 2009, at around the 15000 level. I scaled it down to make it cross the blue in 1947. That makes 1947 the "base year".  You can see that very little of the economic growth we've had has been real growth, and that most of it has just been prices going up. Inflation.

You can also see that, compared to the actual (blue) numbers, Palley's 5% inflation target (green) more than doubles GDP, from less than $20,000 billion to more than $40,000 billion by the end of the 1987-2015 period.


Next, debt. I started with the year-to-year change in debt, because I'm figuring higher inflation for each year. I have to inflate each year's increase in debt separately. Maybe you plan to buy $10 of stuff on credit, but because of inflation it costs $10.50. I have to make an adjustment like that for every year from 1987 to 2015, to create my Palley-plan numbers.

Graph #2

Same colors as before: Blue is actual. Red shows 1% more than actual inflation each year from 1987 to 2015. And green shows an extra 3% inflation on top of actual. The orange line shows no inflation at all, as on Graph #1.

Next, debt again. Now that I have Palley-plan numbers for each year's change in debt, I can take those numbers and add them up to get total debt with the extra inflation already in it.

Graph #3

Now we have GDP and total debt, both adjusted for Thomas Palley's higher inflation targets. All that's left to do is match them up by color and divide debt by GDP. I come up with three different debt-to-GDP curves:

Graph #4

Blue is actual. It is the same as you would get using FRED data. Red shows the ratio when both debt and GDP are figured at an inflation rate one percentage point higher than actual. This is comparable to Palley's 3% inflation target -- one point higher than the existing 2% target -- except I am using actual data from the past rather than a target for the future.

Green shows the ratio when debt and GDP are figured at an inflation rate three points higher than actual. The green is the lowest of the three. One can generalize and say that some inflation brings the ratio down some, and more inflation brings it down more. Of course, this assumes that inflation affects wages and prices equally, and that nobody decides to use any additional credit. But you can see that inflation does have some effect on the debt-to-GDP ratio.

What I see is that the actual ratio peaked with debt at something over 3.5 times the size of GDP, that with 1% higher inflation for the 1987-2015 period, the ratio peaks at something under 3.5 times GDP, and that with 3% higher inflation for the same period, the ratio peaks at something under 3 times the size of GDP.

Is it worth it? Today, instead of having a little over 60 trillion dollars in debt, we would have a little over 70 trillion with the one Palley plan, and almost 100 trillion with the other. That's a lot of debt.

And GDP, instead of being about 18 trillion dollars in 2015, with the higher Palley plan would have been about 42 trillion. But since it is inflation that changed, not real output, it means that under the Palley plan the dollar today would be worth something less than half its present value.

I don't see inflation as a solution to economic problems.


The Excel file. Feel free to check my work.

"Price stability" is not the same as stable prices

A little history from Thomas Palley:

In the 1970’s the economics profession switched to focusing on inflation on grounds that monetary policy could not affect employment and output in any systematic way (Friedman, 1968; Lucas, 1972). Initially, that resulted in a new consensus that monetary policy should aim for price stability (zero inflation). However, a zero inflation target tended to land the economy in the misery zone, so the target was revised up and price stability was redefined as 2 percent inflation.

Price stability was redefined as 2 percent inflation.

//

This graph from Robert Sahr

From SUMPRICE.PDF by Robert C. Sahr (2003)
New Link

shows that price stability was indeed possible over the long run, until, say, the 20th century.

//

But maybe we have it all wrong. Check out this humorous graph from Reddit

Graph #2

The first three comments that show up at the Reddit site all complain that the graph should use a log scale because the "MASSIVE price swings" before 1950 "get obscured by this type of chart." I'd say it depends what you are trying to show. Also, on what the data measures.

But we should all be as happy as kings to see that the massive uptrend since 1950 indicates a massive increase in the "worth of one 1774 dollar".

Palley on Two Kinds of Recession

I'm reading the simple version of Thomas Palley's Monetary Policy and the Punch bowl. In it Palley writes

In effect, the monetary policy framework of the past three decades has had the Federal Reserve pursue “stop-go” interest rate policy, raising interest rates to tamp down Wall Street exuberance and slow the economy before it reaches full employment, and then lowering them again to escape recessions.

Reminded me of Paul Krugman's thoughts on recession that I touched on a couple months back. The "two kinds of recession" are quite clear in the Krugman view, but not so much in the Palley view.

Palley says the recessions of the past 30 years have been brought on by the Fed raising interest rates. That's what Krugman says caused recessions until about 30 years ago.

"Since the mid 1980s," Krugman says,

recessions haven’t been deliberately engineered by the Fed, they just happen when credit bubbles or other things get out of hand.

I don't know now. I think maybe Palley is on to something. What's the same about recessions before and after the mid-80s is that interest rates rise until recession occurs, and interest rates fall until recovery occurs.

What's different in the more recent period is that the Fed raises interest rates in response to "credit bubbles or other things" as Krugman puts it, or, in Palley's words, "to tamp down Wall Street exuberance".

The Fed's focus shifted from inflation to asset inflation. Maybe that's the difference.

Components of Interest Paid

Graph #1: Components of Interest Paid, as Percent of GDP
Households (blue), Federal (green), and US Business (red)

Regarding the debt of non-financial business

In Finance is not the Economy, Bezemer and Hudson

distinguish between two sets of dynamics: current production and consumption (GDP), and the Finance, Insurance and Real Estate (FIRE) sector.

On the one hand, production (and consumption); on the other, finance (and insurance and real estate).

Under the heading The Significance of Household Debt they say

In our time, arguably the most significant form that rent extraction has taken is in the household credit markets, especially household mortgages. The contrast is with loans to non-financial business for production.

Loans to non-financial businesses help the economy grow, they suggest; mortgages don't.

Under the heading Conceptual Differentiation of Credit, they are more explicit:

Loans to non-financial business for production expand the economy’s investment and innovation, leading to GDP growth.

In context, to me, they make it sound as if all (or nearly all) loans to non-financial business are for production.

They may not explicitly say that loans to non-financial businesses are almost always for non-financial purposes, but they open the door to that thought. I think the thought is untrue, and it is unfortunate that the door is opened.

The thought is untrue; consider non-financial corporate business.

Consider the financial assets of non-financial corporate business. Thirty percent of GDP in the early 1950s, financial assets rose to 60% of GDP four decades later, to 90% of GDP two decades after that. Today, they are over 100% of GDP:

Graph #1: Financial Assets of Non-Financial Corporations as a Percent of GDP

Not all of the assets of non-financial corporations are for production. Some of those assets are financial assets which produce financial income but generate no output.

If we look at all of the assets of non-financial corporations to see what percentage of those are financial assets, it turns out that the financial share has doubled, from about 25% to about 50% of assets:

Graph #2: Financial Assets as a Percent of All Assets of Non-Financial Corporations

Today, about half the assets of non-financial corporations are financial assets. That is to say, about half the assets of productive corporations are non-productive assets.


Bezemer and Hudson tell us that

Since the 1980s, the economy has been in a long cycle in which ... [s]peculation gains momentum — on credit, so that debts rise almost as rapidly as asset valuations.

Half the assets of non-financial corporations are financial assets. So probably about half the borrowing of non-financial corporations is for the purchase of financial assets. And if debts rise almost as rapidly as asset valuations, then probably half the debt of non-financial corporations is for financial -- non-productive -- purposes

So when they tell us that loans to non-financial business lead to GDP growth I have to say maybe only half those loans lead to increased output. The other half create financial costs that only increase the price of output.

Oh, and if you are wondering why finance has grown so much, the answer is that financial income is a cost to the non-financial sector. Bezemer and Hudson are absolutely right about that. The growth of finance makes the non-financial sector less profitable, driving investors out of productive investment and into finance, further increasing the growth of finance. This "long cycle" continues until the productive sector can no longer support the financial sector and then, oddly, what happens is called a financial crisis.

The Bleedin' Obvious

From "Fisher Dynamics" in US Household Debt, 1929-2011 by J. W. Mason and Arjun Jayadev (Draft: March 11, 2014). Obvious, but very well said:

When there is the possibility of default, both debtors and creditors will be concerned with debtors' capacity to service existing debt... The greater is current debt, the larger will be the contractually fixed debt-service payments, and the more likely the unit is to face difficulties meeting them.

All else aside, the greater the current debt, the greater the risk of macroeconomic troubles arising from debt. I hope it's obvious!