"... controversy. I wish there could have been less ..."

The title quote is from the Preface to The General Theory.

Mine of 25 July, my critique of Noah's Why did rich-world deficits start exploding around 1980?, that's my idea of an important post. I'm not comfortable holding it up and waving it around like this; forgive me. But I'm looking at the assumptions which underlie an argument made by somebody with credentials; and I find that his assumptions are wrong.

As I said when I looked at it before: If you don't start with facts, even your best theories are bullshit.

Keynes said it better:

For if orthodox economics is at fault, the error is to be found not in the superstructure, which has been erected with great care for logical consistency, but in a lack of clearness and of generality in the premisses.

In the premisses.

I was re-reading mine of the 25th. Then, out with the dog, it struck me: I know what Keynes meant when he said I wish there could have been less controversy. Less of what looks like criticism of other people.

It's not criticism of people. It's criticism of ideas.

When ideas are based on facts that are not true, the ideas are probably wrong. As time goes by, wrong ideas become embedded in a "superstructure" of thought -- in our models of the economy. Then we base economic policy on those models. That's why the economy goes bad.

Keynes didn't want to generate controversy. He had to. It is essential to point out incorrect assumptions. Otherwise people (like Noah) build stories around them.

A footnote on effectual demand

From footnote #11 in Keynes vs. Say at Mises:

The term "effectual demand" was actually introduced by Adam Smith in The Wealth of Nations (Book I, Chap. 7). John Stuart Mill explains. "Writers have … defined [demand as] the wish to possess, combined with the power of purchasing. To distinguish demand in this technical sense, from the demand which is synonymous with desire, they call the former effectual demand." Principles of Political Economy, 1848, Book III, Chap. II, § 3.

Yeah, that's what I thought. That's not what I got when I tried to understand what Keynes said about it. But that's what I thought, before.

In the same footnote, they equate the terms "effective demand" and "effectual demand", as I do:

The phrase "effectual demand," however, was italicized merely to bring out here the fact that Keynes did not invent this phrase. Ricardo even uses the phrase "effective demand" in his Notes on Malthus (Sraffa edition, Cambridge University Press, p. 234).

"Paper Tiger"

From MIA, from 1956, from Mao Tse-tung. From 1956!

The United States owes debts everywhere. It owes debts not only to the countries of Latin America, Asia and Africa, but also to the countries of Europe and Oceania. The whole world, Britain included dislikes the United States. The masses of the people dislike it. Japan dislikes the United States because it oppresses her. None of the countries in the East is free from U.S. aggression. The United States has invaded our Taiwan Province. Japan, Korea, the Philippines, Vietnam and Pakistan all suffer from U.S. aggression, although some of them are allies of the United States. The people are dissatisfied and in some countries so are the authorities.

All oppressed nations want independence.

Everything is subject to change. The big decadent forces will give way to the small new-born forces. The small forces will change into big forces because the majority of the people demand this change. The U.S. imperialist forces will change from big to small because the American people, too, are dissatisfied with their government.

In my own lifetime I myself have witnessed such changes....

FUCK THE EUROPEAN UNION

I got this notice along with my Blogger stats this morning:

The European Union requires me to do something? I have responsibilities here?

FUCK EU

I am not a citizen or resident of the european union or any of its member states. They have no right to tell me any fucking thing. If they want to tell you that you cannot come to this blog, well, if you live there you might have to listen to them. You should do something about that. Leave the union. It's easy.

FUCK EU.

I clicked the "learn more" link and got this from the Blogger Help:

The European Union requires me to do something??? (Sorry, I got carried away.)

To be honest, I don't have any information about cookies used on my blog. I know I like Double Stuf Oreos. I know I like writing about the economy. Oh, and I know I do NOT like political reorganizations based on empty economic promises, such as the european union.

I didn't see any cookie warnings on my blog. So I took the URL

http://newarthurianeconomics.blogspot.com/

and changed the .com to .fr:

and then to .co.uk:

Oops, I cut off the address bar on that one. Well, you get the idea.

Tell you what, I don't like so much the thought that my information might be shared by Google. But that's not really where the problem lies. Companies like Google are allowed and encouraged to become as big as they can get, by governments like mine and yours. That's the real problem, isn't it.

"... it is not the source but the limitation of power which prevents it from being arbitrary."

- Friedrich A. Hayek, The Road to Serfdom

"Any Member State may decide to withdraw from the Union in accordance with its own constitutional requirements."

- The Consolidated Treaty on European Union

Fuck the European Union
Support Sovereignty of Nations

Where was I? Oh yeah, minding my own business.

I went back to the Blogger Help and read this part:

I can do that. I went looking first for anything I might mess up by making changes. I clicked DESIGN on the Blogger bar, then EDIT HTML -- then closed without changing or saving anything.

I went to the Blogger Dashboard, clicked SETTINGS for the blog, then clicked OTHER. Under BLOG TOOLS I clicked EXPORT BLOG and downloaded a backup to my hard drive. Takes a few moments. I folded a blanket and brushed my teeth. When I came back it was done.

I closed the download window, went back to the blog, clicked DESIGN again and EDIT HTML.

The lines are all numbered. Line number 31 had a little black triangle after the line number, and the next line number shown was 655. A bunch of lines were hidden. So I clicked the black triangle. The triangle disappeared, and the missing lines showed up.

I searched for the HEAD tag -- just a LESS THAN symbol followed immediately by the word HEAD. Found it right away, 1 of 1 match. On line 13. (I need to know that.)

Then I searched for cookieOptions to see if I had to change something or just add something. Didn't even find cookie. So I have to add something from scratch.

Okay. The Blogger help says I have to add a SCRIPT tag in the HEAD tag. By "in the HEAD tag" they mean after the line with "<HEAD" in it and before the line with "</HEAD" in it. For my blog that's line 792.

I didn't find that line when I used the Firefox search line at the bottom of my browser. I had to use the Blogger search field that opens in the upper-right of the Edit Window when I press CTRL F. I will just add my SCRIPT tag just after line 13 and before what's on line 14 now. That should work okay.

Okay. I thought about it for a moment and realized I don't know what to put in the SCRIPT tag I have to add. No problem. I Googled it :)

Stuffaboutcode has something on it already. I copied their example to a textfile, put Google's original message back in there, and added a little something of my own.

Then I saved and closed the thing. And it works:

FUCK EU.

Borrowing and debt are related, obviously, but they are not the same.

At Reddit, catapultation described the economic process that drives inequality. He showed a graph of the Federal Funds Rate coming down since 1981 and said:

Lower interest rates means increased debt. Increased debt means increased money in the system. That newly introduced money all trickles up, therefore you get the wealthy with huge income increases. It's not rocket science. It also shows why the idea of "increasing demand" is laughable. All you're going to do is increase the 1%'s income by even more. That new money will still just trickle up to them.

I rather liked that explanation. But somebody challenged him on it, making a good (but unrelated) point about interest rates. Catapultation reiterated:

What's misleading about it? Lower interest rates result in more borrowing, yes?

Unfortunately, he made his point two different ways:

Lower interest rates means increased debt.

Lower interest rates result in more borrowing

Those two statements are not equivalent. I agree, yeah, falling interest rates since 1981 were intended to boost the economy, and most of the new money got scooted off into savings (financial wealth). Plus all that debt is also financial wealth and a source of financial income, draining even more cash away from the "nonfinancial" (productive) sector.

Falling interest rates are one reason we did a lot of borrowing. But we have a lot of debt because there are policy incentives to borrow, and policy incentives to be in debt, and there are no policy incentives to pay off debt as fast as we accumulate it.

I said as much. Catapultation quoted me back

because there are policy incentives to borrow, and policy incentives to be in debt

and replied:

...like low interest rates?

Policy incentives to borrow, like low interest rates; and policy incentives to be in debt, like the home mortgage interest deduction and the business interest deduction.

Moreover, the whole of standard policy -- encouraging spending to stimulate growth, but at the same time restricting the quantity of money to fight inflation -- works like a pump, pumping up the use of credit.

Structure and focus

Bryan Garner's LawProse Lesson #214:

Lawyers’ biggest failing as writers.

What’s the most pervasive flaw among legal writers? It’s the tendency to begin writing before fully understanding the message to be conveyed. Lawyers often don’t think through what they want to say until they’re already writing—and they therefore meander, backtrack, and even restart. Unless they spend a great deal of time rewriting and cutting, they end up submitting something verbose, rambling, repetitious, incohesive, and unpersuasive.

The mature writer first figures out the major propositions and then writes in support of them. The resulting product has both an overt structure and a strong focus.

This method of writing isn’t inborn; it’s learned. With some patience and humility, anyone can learn to do it.

Sometimes I use writing to explore ideas. That counts as "writing before fully understanding the message to be conveyed." Probably unfocused and unpersuasive. But sometimes that's okay.

Actually, for writing about the economy, I count is as a plus if ideas are presented for evaluation rather than crammed down your throat as the hard truth.

It's different for lawyers, I think. Oh, and there are some arguments I make, where I am as focused and convincing as possible. When I'm sure of something and when it's important.

But even the things we're sure of -- especially the things we're sure of -- occasionally need to be reconsidered, thought through again, seen in the light of a changed economy. A changing economy.

The red line

"Why did rich-world deficits start exploding around 1980?" - Noah Smith

Start with the last graph from last time:

Graph #1: Federal Deficits (blue) with Inflation Removed (red) Base Year=1958

Annual change in Federal debt as a measure of deficits, divided by the GDP deflator to remove inflation, then multiplied by 17 (instead of 100) to show dollars from 1958 (instead of from 2009). That's the red line. The blue line is annual change in Federal debt, not adjusted for anything.

Get rid of the blue line:

Graph #2: Inflation-Adjusted Federal Deficits (Base Year 1958)

Okay. The red line here looks similar to the blue line on Graph #1. The three high peaks are lower, of course. Well, all the numbers are lower. All the numbers after 1958 anyway. The three high peaks on the red line, the peaks come at about 75 on the vertical axis, and about 90, and a little under 100.

Those peaks have the same values on Graph #1 of course, but they're easier to see on Graph #2. It's also easier to see what Noah called an "explosion" of deficits on this red line -- if you're looking for it.

Me, I'm not looking for it. I cannot imagine Maynard Keynes or Adam Smith seriously discussing an "explosion" of deficits. I learned what economics is, from them. I learned what economics is not, from Milton Friedman.

It is pretty obvious that the big jump on the graph occurs at the 1982 recession. And it looks to me like the second biggest jump occurs at the 1974-75 recession. Third, probably the 1991 recession. So I have to think that the big jumps in the deficit are recession-related, not 1980s-related.

Does it matter? Well, yeah. If the big jumps are recession-related it means they are Keynesian policy. If they are 1980s-related it means they are Supply-Side policy.

I think we can see supply-side policy on the graph, in the tapering off of deficit peaks. The strong upward trend established by the deficit increases of the 1970 recession, the 1974-75 recession, and the 1982 recession, the uptrend has broken by the time of the 1991 recession. That last peak is lower than the trend suggests it should be.

And after the 1991 recession, the deficits actually fall. Clearly, this is supply-side policy at work. Supply-side, or Reaganomics, or whatever you want to call it. Furthermore, the effects of this policy are delayed -- as we should expect. Policy is not instantaneous: Policy establishes trends.

"Inflation pushes new borrowing up"

That's what I said yesterday: Inflation pushes new borrowing up.

Because things cost more than before. So if we don't change our habits, if we just keep doing the same portion of our spending on credit, then the dollar amount of that portion will rise with inflation. No mystery there.

If "we" happen to be the Federal government, our borrowing is similarly affected by inflation: If we just keep doing the same portion of our spending on credit, then the dollar amount of that portion will rise with inflation.

Federal government or no, there may be other reasons for our new borrowing to rise or fall. Reasons other than inflation. For example, we may choose not to keep doing the same portion of our spending on credit. I'm trying to separate out the inflation from these other reasons.

//

I want to start with FRED's FYGFD, Gross Federal Debt. Graph #1 shows the annual change in Gross Federal Debt, billions of dollars. I'm using it as a measure of the annual deficit of the Federal government:

Graph #1: Year-to-Year Change in the Federal Debt, a Measure of Deficits.

You can look at this graph a couple different ways. You can say the numbers really start going up fast right around 1980. And that's true. But if we chop off everything since 1980 and look at the years before that ...

Graph #2: Wow, the numbers really start going up fast around 1975!

... we might want to say "Wow, the numbers really start going up fast around 1975!"

But then, if we chop off everything after 1970 and look at what's left, we could say "Wow! the numbers really start going up fast around 1966!"

Graph #3: Wow! the numbers really start going up fast around 1966!

And if you look again at that graph, you might happen to notice that the numbers were trending upward right from the start.

All these important facts get squished down to nothing when the graph includes the more recent numbers that are, indeed, much larger nominal values.

Now let's go back again to the graph that goes all the way to year 2000. Graph #1. Let's keep that blue line as is, and put the same debt data on there again -- this time in red. But this time we'll take that red line, annual change in the Federal debt, and take the inflation out of it.

I divided the annual deficits by the GDP Deflator. It's the same exact calculation you would do to convert nominal GDP to inflation-adjusted GDP. Except of course the data we start with is deficits, not GDP. Here is the result:

Graph #4: Annual Deficits (blue) from Graph #1, and the Same Deficits with Inflation Stripped Away (red)

With inflation stripped away, the deficits are higher. Doesn't that strike you as odd? It always bothers me. Inflation makes prices higher, so when When you take inflation out of the numbers, the numbers should be lower.

The reason the numbers are higher is that we're looking at years before the "base year". The base year is 2009. (It's not even on the graph.)

Here's the thing: In the years after 2009, the dollar was worth less because of inflation, so the red line is lower than the blue. But in the years before 2009, the dollar was worth more than a dollar in 2009. So the red line is higher. Simple, right?

I hate it.

The years after the base year are okay. The numbers with inflation in them are higher than numbers without. That makes sense. But in the years before the base year, numbers with inflation in them are lower.

Look: I can explain it and convince myself that it is right. That's not the problem.The problem is, every time there is a graph that compares real values and nominal values, I need the explanation to go with it. Explanations make people's eyes glaze over, and they lose interest. I lose interest.

The confusion arises from the base year. The base year is too recent, too close to the present day. The base year needs to be back at the start of the data. Then we would be looking at the years since the base year, and we would see inflation pushing the numbers up. And there would be none of this confusion about inflation making prices lower in the years before the base year.

At the start, prices were X. Since that time, prices went up. Now, that's simple. You don't have to have an explanation to make it make sense. So I want to push the base year back to an early date. That's just the opposite of what economists do, of course.

Suppose I take Graph #4, the real-and-nominal comparison graph, and change the base year from 2009 to 1958. Why 1958? Because when I first started looking at economic data in the 1970s, the base year was 1958. So I'll keep it there.

I'll just keep it there. When you take the inflation out of a data series, you divide that series by the deflator series. And then you multiply by 100 to bring all the numbers up and make the base year right. That's because the base year is always given the value 100. (You can see it on Graph #4, the text in the left-hand border, we are dividing by Index 2009=100. They set up the deflator so that 2009 has the value 100.

Other years have other values. In particular, the year 1958 has the value 17:

Graph #5: Values of the GDP Deflator

It happens to be a nice round number, but that doesn't matter.

So what I'm gonna do is, instead of multiplying by 100 to bring the adjusted numbers to the 2009 level, I'm going to multiply by 17 to bring those numbers up to the 1958 level. We're still looking at the most recent deflator values, but I'm changing the base year from 2009 to 1958:

Graph #6: Federal Deficits (blue) with Inflation Removed (red) Base Year=1958

Compare the top blue borders of Graph #6 and Graph #4. They are the same except for the first number on the second line. On Graph #6 I am multiplying by 17, to bring the red line values up to the level of 1958 dollars. On Graph #4 I am multiplying by 100 to bring the red line values up to the level of 2009 dollars.

On Graph #4, multiplying by 100 makes the red line higher than the blue line. That's what happens when you're looking at years before the base year.

On Graph #6, it is as if you are standing in 1958 and looking at two different futures. The red line shows Federal deficits with no inflation. The blue line shows Federal deficits with the inflation that we actually ended up with.

There are two areas on Graph #6 that I want you to look at. The area between the black line (the zero level) and the red line represents increases in Federal deficits for reasons other than inflation. Policy decisions and such.

The area between the blue line and the red line represents increases in Federal deficits that were due entirely to inflation.

So now I can draw a conclusion or two: Yes, inflation pushes new borrowing up. Between the mid-1960s and the early 1980s, inflation pushed the blue line up noticeably. Before the mid-1960s, the red and blue lines are indistinguishable.

Oddly however, the big increase occurs after the early 1980s.

The rate of inflation fell a lot in the early 1980s. But the dollar was worth much less after we had the inflation, than it was before. What was a $100 deficit in 1965 grew to $300 twenty years later, solely because of inflation. That's based on the GDP Deflator (which records less inflation than the CPI, for example).

Oh, sure, even with inflation stripped out of them, the deficits increased. The red line shows it. At the time of the 1982 recession the red line makes a big jump -- or, it would look like a big jump if the blue line wasn't there for comparison.

But if you take a big jump in Federal deficits, and multiply it times three to show the effect of inflation, well now you are seeing what looks like an "explosion" of deficits.

//

Yesterday I said:

Inflation pushes new borrowing up, but does nothing to existing debt, so it creates the illusion that deficits are exploding.

Maybe you can see it, on that last graph.

The effects of inflation

Following up on Saturday's efforts, here is Noah's opening:

The U.S. federal deficit, which had been decreasing since the end of WW2, began to trend upward beginning around 1980:

It irks me that an economist (Noah Smith) would look at a graph of debt relative to GDP, and call it "deficits". It is exasperating to see him ignore the effect of inflation and watch him misinterpret the graph because of it. And it is difficult to get people to see what I want to show them.

My Saturday post is just a little bit complicated. Just a little, tiny bit more complicated than Noah's. He talks deficits and shows us debt: He shows the accumulation of those deficits that are his topic. Then he takes that accumulation, divides it by GDP, and starts making claims about deficits.

I complicate Noah's efforts by pointing out that he fails to consider the effects of inflation:

1. Inflation pushes GDP higher, but does nothing to existing debt, so it reduces the ratio of debt-to-GDP.
2. Inflation pushes new borrowing up, but does nothing to existing debt, so it creates the illusion that deficits are exploding.

Noah ignores both these effects, and so misinterprets his graph.