The Components of RGDP/CPI

Friday's graph, output compared to prices, shows three distinct stages: 1947-1966, 1969-1982, and 1983-2011 or so. That graph shows the three stages clearly. But you can't pull meaningful numbers from it. I can't, anyway.

So I went back to the FRED numbers and made a graph comparing the "compound annual growth rate" of real GDP with that of inflation, for those three periods of U.S. economic history:

The rate of real GDP growth was twice the rate of inflation for the 1947-1966 period. GDP growth was one-third the rate of inflation for the 1969-1982 period. And the two rates were near equal for the 1983-2011 period.

On Trends

Slide your mouse pointer along the Number Bar below the graph to see different trend lines fitted to the plot of real GDP growth.

Suppose you take a good long series of numbers, graph it, and then go looking for trends. It is easy to use turning points that suit one's own point of view. Where you place a turning point can make a downtrend look like Reagan's fault, for example, or make it look like a problem that Reagan fixed! Or Obama, even.

I happened to remark to Jerry that

sometimes I try to think of a way to let the computer compare short ranges and longer ranges, and let it search for turning-points in trends. I would have to set parameters, like a five-year or N-year minimum period length. And maybe use least squares to compare various ranges.

A few days later he got back to me:

This turns out to be surprisingly hard to do.

Jerry is the same who created the "Stimulus Watch" gadget on my sidebar, one of the "Debt Accumulation" models, and the "Random Eyes" browser for FRED graphs.

Recently, he got back to me again, with a "gui" version that was so simple even I could use it. Below is a "hover craft" display of trends on FRED data for real GDP growth.

Slide your mouse pointer back and forth on the number-bar below the graph to see computer-generated breakpoints and trends.

Graph #1: Real GDP Growth and Computer-Generated Trend Lines

1 Trend Line

2 Trend Lines

3 Trend Lines

4 Trend Lines

5 Trend Lines

6 Trend Lines

7 Trend Lines

8 Trend Lines

9 Trend Lines

10 Trend Lines

11 Trend Lines

12 Trend Lines

Shall we wonder why?

Which increased faster, prices or output?

Graph #1: Quarterly FRED data for GDPC1 and CPIAUCSL

The numbers on the vertical scale don't mean anything, far as I can tell. With a different base year for Real GDP (or for CPI) those numbers would be different. What is significant on this graph is the uptrend, the downtrend, and the flat trend.

From 1947 to 1966, real output increased faster than prices. From 1969 to 1982, prices increased faster. And since 1983, prices have been increasing almost exactly as fast as real output.

1969-to-1982 is no surprise. That's part of the time called "the great inflation". What's most interesting, I think, is the difference between the years before the great inflation, and the years after it.

A quick glance at the numbers suggests that before the great inflation, real output increased about 44% faster than prices did. After the great inflation, real output increased about 2% slower than prices.

I think this is a remarkable picture.

Not Sure About That

Near the end of Natural Born Recovery Killers Paul Krugman writes

Let me just add that White and others seem in addition to be victims of the fallacy of immaculate inflation. As Karl Smith said in the linked piece,

Inflation must proceed through market processes. Demand for some product must rise or supply must fall.

Any attempt to tell a story about inflationary risks that does not explain where excess demand for goods comes in is, necessarily, monetary mumbo-jumbo.

Karl Smith asserts and Paul Krugman repeats the assertion that inflation "must" "necessarily" be demand-pull inflation.

Not sure about that. Leave aside that PK reduces Karl Smith's demand must rise or supply must fall to the one-dimensional "excess demand for goods". Admit that a fall in supply (relative to demand) *IS* a version of the excess demand for goods.

Is the excess demand for goods the only cause of inflation? I think not.


Inflation was once thought to be driven by "cost-push" forces:

Under Fed chairman Arthur Burns in the 1970s, inflation was seen as cost-push, arising from forces beyond the Fed's control. But Volcker challenged that, seeing inflation as demand-pull. According to Volcker, "the inflation process is ultimately related to excessive growth in money and credit”.

Paul Volcker made the decision that inflation was always the result of excess demand for goods. See, that's where I have a problem. This is not how the economy works. We cannot just make decisions about how the economy works. We have to understand it.

Oh sure, it simplifies everything to say 'inflation is always and everywhere a monetary phenomenon'. Unless it's not true.

Meanwhile, these days, the notion of cost-push inflation is dismissed without a thought. See, for example, the comments following this post.


So, what could possibly cause inflation, other than excessive growth in money and credit? How about expectations?

Economists are big on expectations, as a way to explain everything. Everything other than inflation, that is.


Not what I think. I think expectations as an explanation is a joke. I think Arthur Burns was onto something with cost-push.

Suppose there was an unidentified factor X that was increasing costs for both the supply side and the demand side. On the demand side, X would push living standards down. On the supply side, X would raise costs and reduce profit. The result would be very much like the world in which we actually live.

X is the cost of finance.

It bears repeating

Back in the late 1970s and early 1980s the cult of monetarism was at its height...

Central banks do not directly control the broad money stock or its growth rate. This was the great lesson of those years.

- Lord Keynes

What's in Bernanke's bag?

Excerpts from Chairman Ben S. Bernanke's speech at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, August 31, 2012: Monetary Policy since the Onset of the Crisis

When we convened in Jackson Hole in August 2007, the Federal Open Market Committee's (FOMC) target for the federal funds rate was 5-1/4 percent. Sixteen months later, with the financial crisis in full swing, the FOMC had lowered the target for the federal funds rate to nearly zero...

When significant financial stresses first emerged, in August 2007, the FOMC responded quickly, first through liquidity actions--cutting the discount rate and extending term loans to banks--and then, in September, by lowering the target for the federal funds rate by 50 basis points. As further indications of economic weakness appeared over subsequent months, the Committee reduced its target for the federal funds rate by a cumulative 325 basis points, leaving the target at 2 percent by the spring of 2008.

The Committee held rates constant over the summer as it monitored economic and financial conditions. When the crisis intensified markedly in the fall, the Committee responded by cutting the target for the federal funds rate by 100 basis points in October, with half of this easing coming as part of an unprecedented coordinated interest rate cut by six major central banks. Then, in December 2008, as evidence of a dramatic slowdown mounted, the Committee reduced its target to a range of 0 to 25 basis points, effectively its lower bound. That target range remains in place today.

What's in Bernanke's bag of tricks? Lowering interest rates, that's what.

Unfortunately, although it is likely that even worse outcomes had been averted, the damage to the economy was severe. The unemployment rate in the United States rose from about 6 percent in September 2008 to nearly 9 percent by April 2009--it would peak at 10 percent in October--while inflation declined sharply. As the crisis crested, and with the federal funds rate at its effective lower bound, the FOMC turned to nontraditional policy approaches to support the recovery.

...the FOMC has focused on the acquisition of longer-term securities...

...Federal Reserve purchases of mortgage-backed securities (MBS), for example, should raise the prices and lower the yields of those securities; moreover, as investors rebalance their portfolios by replacing the MBS sold to the Federal Reserve with other assets, the prices of the assets they buy should rise and their yields decline as well. Declining yields and rising asset prices ease overall financial conditions and stimulate economic activity through channels similar to those for conventional monetary policy.

Large-scale asset purchases ... can signal that the central bank intends to pursue a persistently more accommodative policy stance ... thereby lowering investors' expectations for the future path of the federal funds rate and putting additional downward pressure on long-term interest rates...

With the space for further cuts in the target for the federal funds rate increasingly limited, in late 2008 the Federal Reserve initiated a series of large-scale asset purchases (LSAPs). In November, the FOMC announced a program to purchase a total of $600 billion in agency MBS and agency debt. In March 2009, the FOMC expanded this purchase program substantially... These purchases were completed, with minor adjustments, in early 2010. In November 2010, the FOMC announced that it would further expand the Federal Reserve's security holdings ... over a period ending in mid-2011.

About a year ago, the FOMC introduced a variation on its earlier purchase programs, known as the maturity extension program (MEP), under which the Federal Reserve would purchase $400 billion of long-term Treasury securities and sell an equivalent amount of shorter-term Treasury securities over the period ending in June 2012. The FOMC subsequently extended the MEP through the end of this year. By reducing the average maturity of the securities held by the public, the MEP puts additional downward pressure on longer-term interest rates...

What's in Bernanke's bag? Lowering interest rates. But as I showed yesterday, interest rates have been trending down since the early 1980s. And so has growth.

Reducing the Federal Funds rate from 19% to nothing was a long-term act of desperation. It was an unsustainable attempt to boost economic growth. It failed.

Now that the rate has hit its lower bound, Bernanke is pulling all sorts of tricks out of his bag, in an attempt to reduce rates further, to boost growth.

Reducing interest rates to boost growth is a policy that has been failing for 30 years. Something else must be done. An alternative must be found.

Let me say it again: Rather than attempting to reduce interest rates further, we can lower the burden of financial cost by reducing the amount of outstanding private-sector debt. Policy must facilitate private sector deleverage. Give the private sector what it wants.

Relieve the private sector of half its debt. The economy will grow, then.

Volcker broke it. Greenspan surfed it. Bernanke ends up holding the bag.

Interest rates have been trending down since the early 1980s:

Graph #1: Collected Interest Rates
Click for FRED source page

We need a concept that accounts for why interest rates trend up for long periods and then down for long periods. But anyway, this is the FedFunds rate since the '50s:

Graph #2: The Policy Rate

The long trend is up, to the Volcker Peak (1981) and down thereafter. The rate went above 19% in January and again in June of '81. Since then it has fallen to nothing. And what has this done for economic performance?

If a fall of interest rates is good for economic growth, then rates falling to zero must be very good for growth, right? You would think.

Graph #3 shows the percent change ("change from year ago") of nominal GDP with the percent change ("change from year ago") of the FedFunds rate subtracted out of it. What it shows is this: For the sake of boosting economic growth, interest rates have been allowed to fall for 30 years. Growth withered all the while.

This does not mean interest rates should be pushed up. What it means is that, whatever we had before that gave us growth, well, Volcker broke it.

Graph #3: The Urge to Grow

Before Volcker, the economy wanted to grow.

After Volcker, not so much.

Next: What's in Bernanke's bag?

Good question!

I am looking at one graph from Windyanabasis: The Great Unravelling, where (at least according to the Blogger editor) rsj misspells his new name for the Great Moderation.

Which eras are those of moderation, and which are those of excess volatility? What did the central bank succeed in stabilizing as a result of relying on interest rate adjustments rather than income flow adjustments?

Leverage: Domestic Non-financial debt/GDP 1950-1980 versus 1980-2010:

Which era is “moderate”?

Which era is moderate? That's a good question.

rsj expects us to see very little debt growth in the 1950-1980 period, and very much in the 1980-2010 period.

We are looking at debt and output of two thirty-year periods, hoping to get a reliable answer. I know, I know: You think you have a reliable answer.

I disagree.


Let's start with something simple: When economists compare GDP from one year to GDP from another, they generally are looking for a size difference. But they generally want to see the "real" difference, as opposed to the difference due to rising prices. So they take inflation out of the numbers. After that, they can compare output to output to see which is bigger, and by how much.

When economists, hobbyists, and normal people want to compare the GDP of one 30-year period to that of another, we run into the same interference from rising prices. The problem is solved the same way: Take the inflation out of the numbers first.

It's the same story when you compare debt from two different 30-year periods. But it's a bit more complicated, because any one year's debt is itself a collection of debts accrued over many years. So you can't take the inflation out of the debt number the same way you take inflation out of GDP. You have to break up the debt into yearly additions to the total. You have to adjust each year's piece of debt separately.

For more on the inflation-adjustment of debt see Measuring the erosion of debt (PDF).


But rsj is looking at neither debt nor GDP. rsj is looking at the ratio of debt to GDP.

If it was correct to adjust both debt and GDP for inflation by the same calculation, then the ratio of reals would be identical to the ratio of nominals, and this discussion would be moot. But that is not the case.

The inflation-adjustment of debt differs significantly from the inflation-adjustment of GDP. So the ratio of reals differs significantly from the ratio of nominals. Therefore, if it is our intent to compare these values across inflationary time, it is essential to use the inflation-adjusted values.


I downloaded some numbers from FRED, annual data for TCMDODNS, GDP, GDPC1, GDPDEF, and a CPI series that I ended up not using. The original download is the "FRED Graph" page of the Google Docs spreadsheet linked at the bottom of this post.

First step was to duplicate rsj's graph using the FRED data:

Graph #2: Nominal Debt relative to Nominal GDP

You can see the same great flat spot on this graph in the 1950-1980 period, and the same great increase thereafter, just as rsj's graph shows. But this is the ratio of nominals. It is not useful for comparisons in an age of rising prices.

The appropriate graph shows a ratio of reals. For debt, I use incremental inflation adjustment, where each year's addition to debt is adjusted separately. For GDP I use the standard calculation, aggregate inflation adjustment, because GDP is a flow.

Graph #3: Incrementally Adjusted Real Debt relative to Aggregate Adjusted Real GDP

So now let me ask you the same question: Which era is moderate?

Very little debt growth in the 1950-1980 period? I don't see it.

Look. Sorry about the spelling-error thing. I think rsj's post is very interesting. The topic, too. I have no love for the so-called Great Moderation. But if you're gonna set your sights on something in order to take it down, then you need your best argument. You cannot do it with bad graphs.

You can access the Google Docs spreadsheet used for this post.

Sharing is all the rage

I now have this, that google put on my Blogger bar.

But you know what? This (from the sidebar at Blended Purple) is also sharing: