Tuesday, September 19, 2017

In case you don't get it...

David Beckworth, in The Knowledge Problem in Monetary Policy at Mercatus:

Inflation is caused by both supply and demand shocks. Monetary policy can only productively address the latter, but discerning which type of shock has caused inflation in a particular instance is almost impossible for Fed officials to do in real time.

In case you don't get it, Beckworth draws a picture:

See the two circles at the top of the picture? How do we know there are only two circles? It's an assumption. Maybe the picture should look like this:

What could be in that third circle? Here's a thought: policy. Maybe it's policy that's causing the inflation problem. And maybe the solution is not to tighten or loosen, but to try something else with the money. Something like keeping an eye on the ratio of credit to money.

Imagine that.

Monday, September 18, 2017

Beckworth gets it

Milton Friedman quoted JS Mill. I requote it often:

There cannot, in short, be intrinsically a more insignificant thing, in the economy of society, than money ... [Money] only exerts a distinct and independent influence of its own when it gets out of order.

Here's Friedman himself:

Money is so crucial an element in the economy, yet also largely an invisible one, that even what appear to be insignificant changes in the monetary structure can have far-reaching and unanticipated effects.

David Beckworth explains:

... money is the one asset that is a part of every transaction. Whether the transaction is the sale of a physical or financial asset, a good, or a service, money is always a part of the exchange. It reaches into every market. Consequently, destabilizing money destabilizes all markets.

"Money is the one asset that is a part of every transaction." Memorize that.

When a problem affects the whole economy, like inflation or unemployment for example, one of the first things to consider is the money: "Is there a problem with the money?" Always. Even if the problem appears quite certainly to be "peak oil" or "too much immigration" or "China".

Sunday, September 17, 2017


You know about the Fed's 2% target for inflation. Since 2012 I think, that's been the official target.

Thomas Palley, in 1996, in The Atlantic, wrote:

most economists support policies of zero inflation achieved by high real interest rates

Myself, I'm no economist. But I think economists should be embarrassed to support any inflation other than zero. I think they should see the call for 2% as an admission of failure -- a failure of policy, and of the theory behind it.

Anyway, it occurs to me that using high real interest rates to achieve an inflation target has the unintended consequence of increasing aggregate financial costs to the economy. Let's say unintended.

Imagine an alternative way to fight inflation. If we design and implement tax policy to encourage the accelerated repayment of debt, we have a new way to limit aggregate demand. But the new policy includes the intentional consequence of reducing aggregate financial costs to the economy. It may not seem that way now, because private debt remains at such a high level. But as the new policy pushes down debt-to-everything-else ratios, the effect will soon become clear.

Saturday, September 16, 2017

When Palley and Taylor agree...

I switched on a computer that had been off for six months, and found something I didn't remember putting on the desktop: The Forces Making for an Economic Collapse (subtitle: Why a depression could happen) by Thomas I. Palley in the July 1996 issue of The Atlantic.

That's July of 1996.

I was going to quote Palley where he says a new Great Depression has become possible -- 1996, remember -- because it shows remarkable foresight. Instead, I'll file that under Recommended Reading and move on.

Here, Palley describes policy shortly before the "Goldilocks years" of the mid-to-late 1990s were to become obvious in hindsight:

... the Fed now interprets any sign of wage increases as incipient inflation, and responds by raising interest rates. Since wage increases are the means by which labor shares in productivity growth, this policy is tantamount to helping corporate and financial capital to gang up on labor.

The Federal Reserve vividly illustrated its new stance in 1994, when it raised interest rates six times. Just as the long-awaited economic recovery was picking up steam, the Fed slowed employment growth. It claimed that its action was necessary to prevent inflation from accelerating, but never produced compelling evidence of the danger of inflation...

The story since December 2015 is similar.

Palley didn't know it in July of 1996, but the economy was strong enough then to withstand a series of interest rate hikes and move ahead with vigor nonetheless.

We don't know it yet, but the economy today is probably strong enough again to withstand a series of interest rate hikes and still move ahead with vigor. And strong enough for the same reasons.

One more quote from Palley to emphasize the similarity between the 1990 recession and recovery, and the 2009 recession and recovery. While the '90 recession was still fresh in his mind, Palley wrote:

Just as the causes of the 1990 recession have been poorly explained, so have its prolonged nature and the weakness of the subsequent recovery. Economists consider the recession to have ended in the first quarter of 1991, but substantive recovery did not really begin until the second half of 1993. Thus for almost three years the economy was effectively dead in the water.

Dead in the water. We know about that. For crying out loud, even John Taylor in 2016 was saying "In several key ways the US economy resembles an economy at the bottom of a recession, ready for a restart".

Friday, September 15, 2017

Credit is not the same as money (even if you can't see it)

David Glasner at Uneasy Money: Milton Friedman Says that the Rate of Interest Is NOT the Price of Money: Don’t Listen to Him!

In the days before the internet, I wrote to Milton Friedman three times. He wrote back every time. That was great.

Not only that, but I could tell from Friedman's answers that he read and understood what I said. That's a rare and precious thing. For this reason I will always think of Milton Friedman as a great economist, no matter how many problems I have with his economics.

David Glasner quotes Friedman, from the Friedman Heller debate:
... the interest rate is not the price of money... The interest rate is the price of credit. The price of money is how much goods and services you have to give up to get a dollar.

That's it. That's it exactly. I had written to Milton Friedman, and my explanation for what I was thinking was: the interest rate is the price of money. Friedman wrote back to me, saying the interest rate is not the price of money; the interest rate is the price of credit; the price of money is what you have to give to get the money.

I remember, because I had to think about it for years before it made sense to me. Literally, for years.

It made sense, finally, when I realized that credit is not the same as money. Here's how I see it: I can get money two ways. Either I work for it, or I borrow it. If I work, I help to build this civilization and the money is my reward. If I borrow it, I'm going to have to pay it back, with interest.

Credit is not the same as money. The idea came to me direct from Milton Friedman. Having embraced the idea, I can easily see people who have not taken that idea to heart. People like David Glasner, who writes:
What is wrong with Friedman’s argument? Simply this: any asset has two prices, a purchase price and a rental price. The purchase price is the price one pays (or receives) to buy (or to sell) the asset; the rental price is the price one pays to derive services from the asset for a fixed period of time. The purchase price of a unit of currency is what one has to give up in order to gain ownership of that unit. The purchasing price of money, as Friedman observed, can be expressed as the inverse of the price level, but because money is the medium of exchange, there will actually be a vector of distinct purchase prices of a unit of currency depending on what good or service is being exchanged for money.

But there is also a rental price for money, and that rental price represents what you have to give up in order to hold a unit of currency in your pocket or in your bank account. What you sacrifice is the interest you pay to the one who lends you the unit of currency, or if you already own the unit of currency, it is the interest you forego by not lending that unit of currency to someone else who would be willing to pay to have that additional unit of currency in his pocket or in his bank account instead of in yours.

I have a problem with that. Glasner says there is always a rental price for holding money. If it's money you borrowed, he says, the rental price is the interest you pay on the loan. If it's money you earned, money you "own" as Glasner says, there is still an opportunity cost for holding it, and this is its "rental price".

But if the dollar in my pocket is borrowed, I can still choose to lend it out and collect interest on it. If I fail to do that, then by David Glasner's logic I am paying the rental price twice for that dollar, once for interest, and again for the lost opportunity.

So, looking at it Glasner's way, if the dollar in my pocket is my own, I am paying the rental price which is an opportunity cost. But if the dollar in my pocket is borrowed, the rental price I pay is opportunity cost plus interest cost. The cost (or "rental price") of a borrowed dollar is different from that of a dollar I own. Therefore, a borrowed dollar is different from an earned dollar.

An earned dollar is "money". A borrowed dollar is "credit". The opportunity cost for holding money applies to both money and credit. The interest cost applies only to credit.

Milton Friedman was right: The interest rate is the price of credit. David Glasner cannot see it, because he has not embraced the idea that credit is not the same as money.

One more point. I want to leave out the "opportunity cost" part and look at the rest. Glasner says:
But there is also a rental price for money, and that rental price represents what you have to give up in order to hold a unit of currency in your pocket or in your bank account. What you sacrifice is the interest you pay to the one who lends you the unit of currency ...

Glasner says that in order to hold a borrowed dollar, I have to pay interest to the lender. That's incorrect. I don't have to pay the interest because I'm holding the dollar. I have to pay the interest because I borrowed the dollar! Look what happens when I finally spend that dollar: The fellow who receives that dollar does not have to pay interest on it. The interest obligation stays with the borrower.

The interest obligation is part of the same loan agreement that created the credit you could spend. That's what credit is: a "medium of exchange" dollar that moves through the economy, and a dollar of debt that stays with the borrower.

When you borrow a dollar you receive a dollar of money and a dollar of debt sandwiched together. When you spend it, you peel off the money layer, spend that part, and keep the rest. The borrower retains the debt. But the borrowed dollar, once spent, is freed of the debt obligation and is thereby transformed from credit to money.

Thursday, September 14, 2017

New Borrowing, minus Interest Paid (adjusted for inflation)

... changes in borrowing behavior have played a smaller role in the growth of household leverage than is widely believed. Rather, most of the increase can be explained in terms of “Fisher dynamics” — the mechanical result of higher interest rates and lower inflation after 1980.

The year-to-year change in household debt is a measure of the money households borrow into existence and spend into circulation. An increase in household debt is an injection of funds into the money used as a medium of exchange.

But, to state the obvious, an addition to debt adds to debt. And debt must be repaid with interest. Interest is a cost that takes money and moves it from the productive sector to the financial sector. While it remains in the financial sector, the money is not used as a medium of exchange -- not, at least, in the productive sector.

So we can say that an addition to debt increases the money available for spending, and interest payments reduce the money available for spending. If we take one year's addition to debt and subtract from it the payment of interest for that same year, we can calculate a "net change" in money available for spending due to household credit use. Figure it for a number of years, and we can make a graph showing the history of the net change over time.

But the values on such a graph will be influenced by the rate of inflation. The graph will be malformed because the rate of inflation varies. As we are thinking about growth, we must remove the inflation. We can remove it by the same calculation used to remove inflation from "nominal" GDP.

However, I want to use the CPI as the measure of inflation, rather than the Deflator, because we're looking at household debt and household interest costs.

All of this can be done at FRED with a minimum of fuss:

Graph #1: Net Change in the Medium of Exchange due to Household Debt

The description of the calculation (in the upper blue border of the graph) has been cut short by a devious and disappointing FRED. The full description is "(Households and Nonprofit Organizations; Credit Market Instruments; Liability, Level-Monetary interest paid: Households and nonprofit institutions)*(100/Consumer Price Index for All Urban Consumers: All Items)"
The plotted line shows the increase in debt, minus interest paid. The difference has been adjusted for inflation. Where the line is above zero, borrowing is greater than interest cost. Where the line is below zero, borrowing is less than interest cost.

Before 1980, the line is mostly above zero, indicating a net increase in the circulating medium, a boost for spending and growth.

Between 1980 and 2000 the line is mostly below zero, indicating a net decline in the circulating medium due to the cost of interest.

The graph supports JW Mason's statement.

Wednesday, September 13, 2017

It's not a coincidence

At Bloomberg: Act or Wait? Fed Debate Heats Up After Inflation Misses Target by Matthew Boesler, 13 Sept 2017.

The opening words:

Former Federal Reserve Chairman Alan Greenspan, in year nine of a U.S. economic expansion, conceded in 1999 that patience was sometimes a better policy than his doctrine of preemptive interest-rate moves because “the future at times can be too opaque to penetrate.”

For some Fed officials, these days look like one of those times to wait for clarity.

And this:

“The conventional wisdom did not work in the 1990s and it is not working now,” said Allen Sinai, chief executive officer of Decision Economics in New York.

The 1990s and now. It's not a coincidence.

Tuesday, September 12, 2017

The butterfly non-effect

The butterfly effect is a concept that states "small causes can have larger effects".

Macro events (in big economies) don't have micro causes

Scott Sumner has a tendency to say things clearly. For example:

I see the business cycle as being (in Fisher's words) a "dance of the dollar". Unstable monetary policy shows up as unstable NGDP. Since wages are sticky, employment tends to move with NGDP in the short run, and unemployment is countercyclical. Recessions occur when a sharp decline in NGDP growth leads to a rise in unemployment ...

In other words:

Monetary Policy --> NGDP Growth --> Employment Growth --> Recession

There's no place for butterflies there.

Like Sumner, I see monetary policy as causal. We differ because, for me, monetary policy should include not only money but also credit; and the credit-to-money ratio is of the utmost importance. But we agree that monetary policy is causal.

I also agree with Sumner (or, say Okun) on the relation of GDP growth and employment growth; and certainly recession may follow from changes in GDP and employment.

But where Sumner has NGDP Growth, I would instead put Spending Growth:

Monetary Policy --> Spending Growth --> Employment Growth --> Recession

I would have a second arrow coming out of Spending Growth, pointing to NGDP Growth on a different line. Other things would be pointing to NGDP Growth as well. Butterflies included.

Monday, September 11, 2017

Does not contradict my prediction of booming RGDP

Capacity Utilization is going up again:

Graph #1
(Does contradict those who expect recession within the next two years.)

Imagine the improvement possible if Capacity Utilization were to rise from 75% to 85 or 90 percent. Look at the size of the increases after the 1970 and '74 recessions. Such things are possible. Such things were possible, I should say. For us, too much, too soon.

Okay, so look at the increase after the 1991 recession: five percentage points. That would get us to 80% and (for those whose memories go back as far as 2008) that would seem pretty good. But 80% is still low: Look at the graph. We should expect to approach 85%, as in the 1980s and '90s.

And, because recent patterns of debt and debt service are comparable to those of the 1990s, we should expect a sustained high in capacity utilization and in economic growth, as in the '90s. Maybe longer, as the fall of debt was deeper and people are more cautious now about adding to their debt.

This would be the perfect time for policymakers to create tax incentives designed to accelerate the repayment of private debt.

Saturday, September 9, 2017

"Don't Look Now," Bloomberg says, "But Productivity Is Finally Rising"

At Bloomberg: Don't Look Now, But Productivity Is Finally Rising.

I told you so.

The Bloomberg post is date 7 September 2017.

On 17 November 2016 I explained Why Labor Productivity is Low, and said

We are in a transition now that will soon give way to a more vigorous economy. Debt Service is beginning to increase, and productivity will soon be on the rise.

On 21 August 2016 I looked at productivity (real output per hour) for 22 data items (five years plus) beginning in 2011Q1. The linear trend ran low (near 0.5 percent growth) and flat.

I looked also at the nine quarters from 1993Q1 thru 1995Q1. The linear trend ran low (near 0.5 percent growth) and flat. But during the nine quarters from 1995Q1 thru 1997Q1, the trend increased from 0.5 percent to nearly 3%. "You never know," I said.

"To my way of thinking," I wrote,

Graph #1 (our time) is very much the same as Graph #2 (the early 1990s). But I think we are at the end of Graph #2 and ready to start Graph #3 [productivity improvement]. That makes all the difference.

"Oh come on," you are saying. "Graph #2 shows only a couple years. Graph #1 shows almost six years. There's no comparison. The slump is endless this time."

It's not endless. That's the point. The quiet time before the vigor is longer this time -- about 2½ times as long, my guess. I'm telling you we are at the end of the quiet period. Soon we will see productivity start to climb, just as on Graph #3.

On 7 April 2016 -- almost a year and a half ago -- I said

I predict a boom of "golden age" vigor, beginning in 2016 and lasting eight to ten years. It has already begun. In two years everyone will be predicting it.

And on 3 March 2016, in We are at the bottom now, ready to go up, I said

This is not going to be your typical anemic recovery. This is going to be the full tilt, rapid output growth, rapid productivity growth, high performance boom.

I can't promise you it'll last long, because the level of debt is already very high. But it'll be a good one while it lasts.

On 7 September 2017, Conor Sen of Bloomberg said Don't Look Now, But Productivity Is Finally Rising.

Friday, September 8, 2017

Remember Alan Greenspan in 1995, talking about anecdotal evidence?

In the last year or two we've seen a lot of improvement in jobs and employment, and economists were confounded by it because inflation didn't accelerate. And now they talk about how the Phillips Curve is "broken". They refuse to consider the possibility that the kind of good economy we had in the latter 1990s could return.

Tim Duy at Economist's View, quoting Cleveland Federal Reserve President Loretta Mester:

... my current assessment is that inflation will remain below our goal for somewhat longer but that the conditions remain in place for inflation to gradually return over the next year or so to our symmetric goal of 2 percent on a sustained basis. These conditions include growth that’s expected to be at or slightly above trend ...

... the 70 percent confidence range for forecasts of PCE inflation one year ahead is plus or minus 1 percentage point, and a significant portion of the variation in inflation rates comes from idiosyncratic factors that can’t be forecasted. Indeed...


...forecasted. Indeed, since the 1990s, assuming that inflation will return to 2 percent over the next one to two years has been one of the most accurate forecasts.

Tim Duy responds:

Since 1990, a 2 percent forecast has worked more than not, so lets just stick with that as the baseline for policy? By that logic, since the great recession, a 1.75% forecast has worked more than not, a testament to the Fed's one-sided inflation target and falling inflation expectations. I am not buying into her inflation forecast story yet.

He's a pretty good read.

As Duy points out, the more recent inflation numbers have been lower. Thinking in terms of averages, if the average since 1990 is 2% and the average since 2009 is 1.75%, then the average for 1990-2009 must be higher than 2%. Thinking in terms of year-on-year results, this appears to be the case:

Graph #1: Core PCE Inflation (the Fed's measure of choice) since 1990

Looking at that graph, I just want to remind you that the latter 1990s were pretty good for employment and income and real GDP growth, not just for price stability. Economists consider that a fluke, though. They refuse to consider that it could happen again. In the last year or two we've seen a lot of improvement in jobs and employment, and economists were confounded by it because inflation didn't pick up as well. And now they talk about how the Phillips Curve is "broken". But they refuse to consider the possibility that the kind of good economy we had in the latter 1990s could come back.

Duy quotes New York Federal Reserve President William Dudley:

Overall, the economy remains on a trajectory of slightly above-trend growth, which is gradually tightening the U.S. labor market. Over time, this should support a rise in wage growth. When combined with [other] factors, that causes me to expect inflation will rise ...

See? Dudley cannot imagine that inflation will remain calm as the economy improves -- broken Phillips Curve or not. A repeat of the latter 1990s is inconceivable to him.

(President Dudley says he expects inflation to rise just to the Fed's target and stop there (at 2%) but doesn't say why. Not by natural causes, certainly. By aggressive rate hikes, should inflation attempt to exceed its target. Typical Fedspeak. Dudley isn't predicting inflation. He's threatening to act against it.)

Duy further quotes William Dudley:

But, the upward trajectory of the policy rate path should continue to be shallow, in part because the level of short-term interest rates consistent with keeping the economy on a sustainable long-run growth path is likely to be considerably lower than it was in prior business cycles.


Duy quotes more:

If it turns out that structural changes have played a significant role, I would generally view this as a positive, rather than negative, development. It would imply that the U.S. economy could operate at a higher level of labor resource utilization without generating a troublesome large rise in inflation. More people could be put to work on a sustainable basis, enabling them to gain opportunities not just to earn greater income, but also to develop their skills and grow their human capital.

And Duy says this suggests

a downward revision of estimates of the natural rate of unemployment.

Tim Duy is right.

Notice that Dudley mentions "structural changes" (but fails to identify the changes or their causes), says it's a good thing (ooh, ooh, maybe he can imagine that inflation will remain calm as the economy improves! Nah, it's probably just words). And the rest of the paragraph just gets giddy. Rather than explaining the fall of the natural rate of unemployment, he gives us the happy ending.

Duy again:

Separately, on the data front, we get this from Commerce, via Reuters:

The U.S. economy probably grew faster than reported in the second quarter, with data on Thursday suggesting stronger consumer spending than previously estimated.

The quarterly services survey, or QSS, from the Commerce Department implied consumer spending increased more briskly than the 3.3 percent annualized rate reported last week in its second estimate of gross domestic product.

The Fed forecasts are based on more modest growth numbers. Stronger growth numbers will tilt them toward further rate hikes.

Yup: If growth improves, policymakers expect inflation. They simply refuse to consider the possibility that the economy might actually be good for a few years.

Nobody remembers the Alan Greenspan of 1995, talking about anecdotal evidence and refusing to raise rates as the economy improved.

Wednesday, September 6, 2017

I'm with Menzie

From Demystifying the trade balance: Why a trade balance deficit isn't necessarily a sign of a poor economy at the FRED Blog:

Is it bad to have a trade account deficit? If this means that your economy is booming and local production cannot keep up with demand, then no. If it implies that there is a current account deficit and, hence, foreigners are investing in your country, then also no. If this means that you can have more investment without having to save more, because the rest of the world is picking up the slack, no again. If you are worried that in the future dividends will flow abroad, then yes. But that will happen only if your economy is in good shape in the first place and will be able to afford paying such dividends.

From US Withdrawal from KORUS Free Trade Agreement?

This is not to argue we couldn’t have more aggregate demand redistributed to the US — in my recent paper on global imbalances I argue that in fact it would be desirable for the US to have a smaller current account deficit.
Menzie Chinn

Friday, September 1, 2017

Paying down debt is a better way to fight inflation than raising interest rates

Why is paying down debt a better way to fight inflation than raising interest rates?

Paying down debt takes money out of circulation. Raising interest rates doesn't.

Paying down debt reduces financial costs. Raising interest rates increases them.

Paying down debt affects those who have borrowed. Raising rates affects everyone.

Paying down debt to fight inflation also reduces debt.

Reducing debt encourages growth. Raising rates discourages growth.

Paying down debt is a better way to fight inflation than raising interest rates.