I See Red

Marcus quotes Wolfgang Munchau quoting Olli Rehn:

“Carmen Reinhart and Kenneth Rogoff have coined the ‘90 per cent rule’,” he said. “That is, countries with public debt exceeding 90 per cent of annual economic output grow more slowly. High debt levels can crowd out economic activity and entrepreneurial dynamism, and thus hamper growth...”

High debt levels can crowd out economic activity.

It's true, you know. Debt is a problem. Look at the graph:

Graph #1: Debt, debt, and Best-Case Growth
Blue: Gross Federal Debt as a Percent of GDP
Red: Debt Other Than Federal Debt, as a Percent of GDP
Green: Percent Change in Potential GDP as a Measure of Best-Case Growth

The blue line (after about 2010) is what concerns Carmen and Ken.

Me? I see red.

without the pleadings of self interest

"Time doesn’t run backwards."

This is the best put-down I think I've ever seen, of "expectations" in economics. From Steve Roth:

... cause really does almost always precede effect. Time doesn’t run backwards. (Unless you believe, like many economists, that people, populations: 1. form both confident and accurate expectations about future macro variables, 2. fully understand the present implications of those expectations, and 3. act “rationally” — as a Platonic economist would — based on that understanding.)

But while I'm on the subject of expectations, I want to round up some excerpts from Maynard. From The General Theory, Chapter 5: Expectation as Determining Output and Employment:

ALL production is for the purpose of ultimately satisfying a consumer. Time usually elapses, however — and sometimes much time — between the incurring of costs by the producer (with the consumer in view) and the purchase of the output by the ultimate consumer. Meanwhile the entrepreneur (including both the producer and the investor in this description) has to form the best expectations he can as to what the consumers will be prepared to pay when he is ready to supply them (directly or indirectly) after the elapse of what may be a lengthy period; and he has no choice but to be guided by these expectations, if he is to produce at all by processes which occupy time.

... It is upon these various expectations that the amount of employment which the firms offer will depend. The actually realised results of the production and sale of output will only be relevant to employment in so far as they cause a modification of subsequent expectations...

It would be too complicated to work out the expectations de novo whenever a productive process was being started; and it would, moreover, be a waste of time since a large part of the circumstances usually continue substantially unchanged from one day to the next. Accordingly it is sensible for producers to base their expectations on the assumption that the most recently realised results will continue, except in so far as there are definite reasons for expecting a change.

So the rule is that expectations are based on existing conditions (or "recent results").

For the world's economists, everything depends on expectations. For me, expectations depend on the results we're getting now.

Which come first? Easy. Results come first. Results set the standard.

Graph #1: US Real GDP Growth Rate Since 1975

See that high spot there, that big peak just before 1985? That was expectations. That's what we got from electing Ronald Reagan. Everybody had great expectations.

But it didn't last. Look at the graph. Everything since 1985 stinks.

// update, 4:03 AM

By coincidence, Marcus yesterday showed this graph,

Graph #2, Source: Marcus Nunes

He pointed out the low spot in it, and wrote:

I wonder if the July 1932 ‘bottom’ is associated with FDR´s nomination acceptance speech on July 2, 1932.

Yes to that. I think that's how "expectations" works. You get a great surge of optimism or pessimism that cannot last long. Cannot last, because it's based on expectations rather than on economic fundamentals like cost. You get a trend anomaly and that's about it.

Checking my work

In ‘Keep it simple’, Marcus Nunes writes:

I may be missing something vital, but what bothered me about the R&R ‘fall-out’ was that the original study was concerned with public debt/GDP levels. The major finding of the critics was that, contrary to the original study, no ‘tipping-point’ (after which growth is negatively affected) was found.

My take: Debt results from deficits. Deficits follow government spending (given revenues). So why not go to the ‘source’, i.e., government spending, and check if it has a measurable impact on growth.

My kneejerk was to object to this simplification: "Debt results from deficits. Deficits follow government spending (given revenues)."

I'm not saying it's not true. It's simple arithmetic: If you spend more than your income, you have a deficit. If A is less than B, then A-B is less than zero. But it makes me cringe because there's no economics in it.

Marcus isn't the only one to look at deficits this way. People commonly look at deficits the way Marcus does in the excerpt. But it ignores all of the economic forces that may have come into play, forces that may have held back GDP growth, held back income growth, and held back tax revenue growth on the one hand. And on the other it ignores all the forces that may have worked themselves out by demanding the expansion of government spending.

No. Instead of that, we have B is greater than A.


And then I thought about my objection to Milton Friedman's MRTO graphs. Friedman compares "the quantity of money relative to output" to the price level, and finds great similarity.

My objection to Friedman's graph is that he forces the price level into the "money to output" ratio by removing the price level from the denominator of that ratio. The similarity that appears in the graph is due to circularity in the arithmetic. The similarity is manufactured by the calculation.


So Marcus relies on simple arithmetic to analyze deficits, and I object to that. On the other hand, Friedman ignores the simple arithmetic that invalidates his MRTO graph.

Friedman describes economic forces and I object based on simple arithmetic. Nunes uses simple arithmetic and I object based on economic forces.

I don't know what to make of this, but I want to think about it some.


Well that was easy.

Friedman relies on economic forces to show what he shows. But simple arithmetic shows the circularity that invalidates his work.

Nunes relies on simple arithmetic to show what he shows. But he ignores the economic forces that describe what is really going on.

Two factors that are important for growth

Yesterday I quoted two paragraphs from Simon Wren-Lewis, expressing two ideas.

The first paragraph described a relation between "contraction in government spending" and the lack of economic recovery.

The second pointed out that a high level of government debt creates a barrier preventing the expansion of government spending sufficient to generate economic recovery.

I suggested that the way to deal with these two facts, assuming they are facts, is to reduce private sector debt. Private debt reduction accomplishes the same thing as increasing government spending: It reduces the ratio of private to public debt.

I don't get into why reducing that ratio is important; the reason probably has to do with sectoral balances. That's not my area. But I have shown repeatedly on this blog that reducing the ratio is an effective (read: necessary) way to boost economic growth.

I've also shown a relation between debt relative to circulating money and economic performance. You can't read this blog without tripping over my "Debt per Dollar" graphs.

What I'm saying is this: Two factors are important to growth. One is the balance between public and private debt. The other is the level of total accumulated debt relative to the quantity of circulating money.


So I was thinking about this. I have two factors, two ratios. The one is the ratio of private to public debt, something I've considered several times here. The other is the level of debt, per dollar of circulating money. I've looked at that a lot, too. But I never looked at the ratio of these two ratios.

1. The ratio of private to public debt:

Ratio #1: Total debt (TCMDO) less its Federal component, relative to Gross Federal debt.

2. The level of debt per dollar of circulating money:

Ratio #2: Total Debt, relative to Circulating Money
Blue: Relative to M1SL (excludes "Sweeps")
Red: Relative to M1ADJ (includes "Sweeps")

(I use M1ADJ, the honest measure after 1994. To display the maximum number of years, I show M1SL for the early years (1959 thru 1995).)

3. The ratio I've not looked at before, which is Ratio #1 relative to Ratio #2:

Ratio #3: The Ratio of Private to Public Debt, Relative to Debt per Dollar

Ratio #3 shows increase during the "golden age" which ended with the 1974 recession.

It shows decline from 1974 to the 1990s. The decline shows what Scott Sumner says: "I am not denying that growth in US living standards slowed after 1973". It shows what Ross Perot showed, back in 1992: decline for two decades after 1973.

The ratio shows increase from 1995 to the 2001 recession, a time when the economy's performance has been called a macroeconomic miracle.

The ratio shows decline thereafter.


The ratio of ratios goes up during the good economic performances from the 1950s to 1973 and from 1995 to 2000. Otherwise it goes down.

The ratio of ratios compares two factors that are important for growth: the ratio of private to public debt, and the ratio of debt to circulating money.

I really shouldn't have to write any more. This should be the blog post that ends all debate regarding economic performance. Study these graphs till the cows come home.

Something else entirely

Simon Wren-Lewis describes events since 2008:

Go into detail within the advanced economies group, and the pattern is clear: the greater the contraction in government spending relative to previous recoveries, the slower the recovery has been.

Their analysis also shows us one of the reasons why this happened. The advanced economies started the recovery with debt to GDP almost twice its average level in previous recoveries.

So the lesson here is that having lots of government debt is bad because if the economy turns to shit, the government is handicapped by its debt. The government is prevented from enlarging its deficit spending to fight recession because of the size of the debt it already has.

Yes, okay, if you insist: The government is prevented by wrong-headed fools from enlarging its deficit spending to fight the recession. Feel better now?

Don't you see it doesn't do any good to look at things that way? They don't think they're wrong. (Actually, they think you are wrong.) And they obviously have the upper hand, for we are in fact prevented by them from the enlargement of deficit spending enough to create a recovery.

So maybe it's not them that are the fools, after all.


What did I say?

The government is prevented from enlarging its deficit spending to fight the recession, because of the size of the debt it has already.

I think that's an accurate description of what happens.

And I think there's some merit to it. You know better, I know you do. The government debt's not the problem. You know it. I know it too, but that doesn't get us anywhere.

See, here it is: You say the government debt is not the problem. But the other guys say the government debt is not the solution.

You say the government debt is not the problem, but you mean you want to use government debt as the solution.

The other guys know government debt is not the solution, because we already have very very much of it, growing since Reagan (though they may not actually say "since Reagan"), this massive government debt, and despite all that debt the economy is garbage, no better than garbage.

So, with some justification, they think that expanding the government debt is not even worth considering. Even though you know that government debt is not the problem.

And even though you are right.

But it is one thing to say government debt is not the problem. And it is something else entirely to say government debt is the solution.


Excessive private debt stands in the way of economic growth. Our goal must be to reduce private debt.

Zoho it is, then

Konczal's R&R screen clip, again:

I put the country names and the debt/GDP values from Konczal's clip into a Zoho spreadsheet so we can play with it online. You can edit the zoho and see the results (and even save it as an Excel file if you want, apparently). You won't mess up my Zoho sheet. If you refresh the page, all your changes go away.



Look in particular at the values on Zoho row 29. These are the R&R error cells. Click on Cell B29, then look up at the top line of the Zoho to see what the formula is. It says:
=AVERAGE(B4:B18)
Here's what I want you to do: With Cell B29 selected, press DELETE to erase the formula. Now, type the EQUAL sign and the word AVERAGE and then open parenthesis (that's SHIFT 9 on my keyboard). Next, click Cell B4 and hold the mouse button down, then drag down to row B23. Release the mouse button. Press ENTER.

Zoho closes the parentheses for you, and calculates the average value for the cells you selected. The cell value changes.

On my computer when I do the next step the screen jumps. Just scroll back so you can see everything again.

Select Cell B29 again, and press CTRL C to copy the formula you entered.
(Scroll the screen if necessary, but don't click or type anything.)

Select cells C29 through E29 and press CTRL V to paste your formula into those cells. The values change because of your new formula.

You did it! You fixed R&R's error!

The Same Old Story

Two days ago I wrote:

Growth was slowing the 1970s, Sumner says.

Sure, because the Fed kept creating recessions to slow things down. Because of the inflation.

But the problem was not that growth was slow. Slow growth was a policy goal in the 1970s. If growth was slowing in the 1970s, it was a policy success. It is utterly wrong to turn that around now and pretend that slow growth was the problem.

Sumner is analyzing the wrong problem. They all are.

Yesterday I wrote:

The problem in those years was not that we couldn't get good growth. And the problem was not that we couldn't keep inflation at bay. The problem was that we could not do both at the same time.

In 1977 I wrote:

The problem that was so magnificently solved during the 1960s was the either/or cycle, of inflation and unemployment. The problem of the '70s, as we well know, is not either/or, but both. Stagflation, it has been called; a new name, describing a new problem.

For nearly a decade, we have been trying to solve a "both" problem with "either/or" solutions. Little wonder we have met with little success in the '70s!

In order to solve the economic problem, we must know what the problem really is.

Wrong Problem Redux

Let me pull out from yesterday's post several bits of excerpt from Scott Sumner. I'm taking everything Sumner after the topic-phrase "US growth before and after 1980".

There's one little piece I don't need today; I scratched it out.

Sumner, in yesterday's sequence:

Growth has been slower [since 1980], but that’s true almost everywhere. What is important is that the neoliberal reforms in America have helped arrest our relative decline...

...neoliberal reforms lead to faster growth in real income, relative to the unreformed alternative.

The neoliberal revolution occurred precisely because growth was slowing almost everywhere in the 1970s and 1980s, and after 1980 growth slowed the most in those countries that reformed the least.

And his summary:

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.

So what is Scott Sumner saying, really? Seems to me he says two things. He says there was a problem: Growth was slowing in the 1970s. And the second thing he says is that the neoliberal reforms "helped arrest our relative decline". I have problems with both of these statements.

First of all, the reforms did not solve nor even partially solve the problem. Making the economy grow faster is not the same thing as eliminating the cause of slow growth. The latter is a solution. The former is a tweak.

The problem was never solved. The neoliberal reforms used several work-around techniques to compensate for the problem of slow growth. Even if the reforms fully compensated for the decline, which Sumner admits they did not, the underlying problem would not have been solved by work-around reforms.

Secondly, what was the underlying problem? "Growth was slowing," Sumner says. I do not agree that slowing growth was the problem. Not in the 1970s. Look at this graph from Marcus Nunes:

Graph #1 Source: Marcus Nunes

Marcus shows inflation-adjusted GDP on a log scale, so that a constant growth rate appears as a straight line. In red, he shows a constant-rate trend line. And he marks up the graph to identify different periods. I wish to focus on the period labeled "G.I." for "Great Inflation" -- the inflationary years from 1965 to 1980.

Marcus's graph shows the blue line at or above trend for the entire inflationary period. By contrast, before 1965, and again after 1980, the blue line is at or below trend. The inflationary period seems to show particularly good economic performance. I find this odd, because Sumner (and everyone) says growth was not good in the 1970s. Sumner says "growth was slowing". Marcus's graph does not agree.

(Yes I know, there was inflation in those years, and it was a problem. But an inflation problem is not the same thing as a slow growth problem. And neither of those is the same as our actual problem, which was that better growth would come only with more inflation. We could no longer separate the two.)

Growth was well above trend in the inflationary years. But perhaps being above trend is not the same as good economic performance? I went to FRED, duplicated Marcus's graph, and added a trend line by eye, matching as best I could Marcus's red line from Graph #1:

Graph #2: Inflation-Adjusted GDP (blue) on a Log Scale with a Trend Line Added by Eye

The FRED graph shows recessions as gray bars, so now we can see that the recession of 1970 brought the blue line down to trend, as did the 1974 and 1980 recessions, and the 1982 recession brought it below trend. But apart from times of recession, in the 1965-1980 period the blue line tends not only to run above trend, but also to pull away from trend. To increase more rapidly than trend. To grow faster than trend. Repeatedly, each time until the Fed restrains growth to combat inflation.

Looks to me like growth was very good in those years. Too good, you might say. Maybe so, but that is not what Sumner says. "Growth was slowing", Sumner says.

You can't have it both ways.

The real problem was not that growth was slowing in the 1970s. We were getting good growth. The problem was, we couldn't get good growth without inflation. Growth could easily have remained vigorous, if we were foolish enough to accept the inflation.


The problem was not that growth was slow. We could have fixed that by the traditional methods. Nor was the problem inflation. We *did* fix that by the traditional methods. The problem was that the range of good options narrowed and then disappeared. The economy changed. There was no longer a golden zone where we could have decent growth and reasonable price stability at the same time. This was the problem.

To put it in terms an economist might understand, the Phillips curve shifted away from the origin.

The problem in those years was not that we couldn't get good growth. And the problem was not that we couldn't keep inflation at bay. The problem was that we could not do both at the same time.

That much remains true today.