Get an Education

Raghuram Rajan:

What is the alternative to creating new mountains of consumer debt? Instead of looking for ways to resuscitate spending by those who can ill afford it, and creating unsustainable bubbles in the process, we need to think creatively about how Americans can acquire the skills they need to enhance their incomes.

Acquire the skills, Rajan says. If your accumulation of debt is too big, he says, get an education. You'll make more income and get out of debt.

Fallacy of composition. It works for the individual. It doesn't work for the economy as a whole. Money comes from somewhere. If we don't borrow it, we have to get it from someone else.

If the stock of circulating money (the money we can get from someone else as income) is insufficient, then the economy does not have the money we need unless we borrow it. This is not a problem that can be solved by education. It can only be solved by economic policy that considers the quantity of circulating money and the level of accumulated debt.

Graph #1: Total Debt per Dollar of M1 Money  1916-2015

In case you didn't read all the way to the end

What I said to Larry Summers last time:

We need to get interest costs down to get economic growth so that we can raise interest rates and undermine that growth. This is your plan for the economy. What's to understand?

Larry, you crack me up. All this focus on interest rates. And no focus at all on the number of dollars on which interest must be paid. You guys cut interest rates, as low as they can go. Now you're trying silly stuff with negative rates -- an act of desperation, to be sure. But you pay no attention to the accumulation of debt. It's the accumulation of debt that created the need for low rates.

Cut debt in half, Larry, and you cut interest costs in half. What's to understand?

Dear Larry,

Notes on Larry Summers's Interest rates are at inconceivable levels, and we must confront what that means


Larry, you are thinking inside the box.

The U.S. 10- and 30-year interest rates on Wednesday reached all-time lows of 1.32 percent and 2.10 percent...
Such rates would have seemed inconceivable a decade ago ...
[E]xtraordinarily low rates reflect both sub-target expected inflation even over long horizons and very low real interest rates...
Remarkably, the market does not now expect a full Fed tightening until early 2019. This is despite all the Fed speeches expressing optimism about the economy and a desire to normalize interest rates...

There is a growing sense that the world is demand-short — that the real interest rates necessary to equate investment and saving at full employment are very low and often may be unattainable ...

First of all, Larry, you are explaining "demand-short" in terms of interest rates. Don't do that. It gets you to interest rates too soon. Actually, you skipped the explanation altogether and went straight to your conclusion that the interest rates we need are unattainably low.

Let's say you're right. Then the question is: Why? Why are rates so low? And how did rates get that way? In other words, Larry, we still need an explanation. (And then, maybe it is not the need for low rates that is the problem. Maybe it is the thing that created the need for low rates that is the problem. See how that works?)

The situation is different now. Not like before the crisis. The situation is different, but your thinking is no different. You are still relying on concepts and short cuts that you used back in 1991 when you were wrong about the 4.5% mortgage rate being an "antique". In truth, Larry, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry, if you get my drift.

Second: Are you relying on loanable funds theory? Sounds like it. Savings and investment are not made equal by interest rates. They are made equal by accounting convention.

And then, Larry, and then you look at the world around you, you describe what you see, and you call it "the result" of the conclusion that you jumped to.

Look what you wrote, Larry:

There is a growing sense that the world is demand-short — that the real interest rates necessary to equate investment and saving at full employment are very low and often may be unattainable given the bounds on nominal interest rate reductions. The result is very low long-term real rates, sluggish growth expectations, concerns about the ability even over the fairly long term to get inflation to average 2 percent, and a sense that the Fed and the world’s major central banks will not be able to normalize financial conditions in the foreseeable future.

 

So. Having fitted the post-crisis world to your pre-crisis economics, and having identified the problem by proclamation, you now move on and consider solutions.

Having the right worldview is essential if there is to be a chance of making the right decisions.

Good point, Larry. I agree with that.

Here are the necessary adjustments:

First, with differences between countries, neutral real interest rates are likely close to zero going forward... There is no good reason to think given sluggish investment expectations that the neutral rate will rise to be significantly positive in the foreseeable future... Substantial continued reductions in Fed estimates of the real neutral rate lie ahead.

Larry, you are doing it again. Starting with low interest rates. Fact is, interest rates in the U.S. have been drifting down hill since 1981. Maybe we should think about that. Maybe we should think about why that. Don't start with interest rates being low at the moment. That's what you thought about your parents' mortgage rate. Think instead about why rates went down for 34 years.

Maybe there is more to it than just interest rates. Get my drift, Larry? Having the right worldview is essential. Without it, you end up saying things like "Substantial continued reductions in Fed estimates of the real neutral rate lie ahead."

They've been lowering rates for 34 years, Larry, and now they've reached the zero bound. The only interest rate left for them to lower is their estimate of the real neutral rate. You're not telling me anything useful, Larry. Anyway, you got to your conclusion by jumping.

Second, as counterintuitive as it is to central bankers who came of age when the inflation of the 1970s defined the central banking challenge, our problem today is insufficient inflation.

No, Larry. Our problem is not insufficient inflation.

Third, in a world where interest rates over horizons of more than a generation are far lower than even pessimistic projections of growth, traditional thinking about debt sustainability needs to be discarded. In the U.S., the U.K., the Euro area and Japan, the real cost of even 30-year debt will be negative or negligible if inflation targets are achieved. Indeed, the conditions Brad DeLong and I set out in 2012 for expansionary fiscal policy to pay for itself are much more easily satisfied today than they were at that time.

Thinking inside the box, Larry. The Keynesian box. Keynes said deficit spending, so Larry Summers says deficit spending. Get out of the box, Larry. Think for yourself. We've had 80 years of deficit spending in the public and private sectors. Maybe it is time for something else. Get out of the box.

Want a hint? I'll give you a hint. What happens when you have 80 years of deficit spending in the public and private sectors? You accumulate a lot of debt, that's what happens Larry. (HINT: Maybe the problem is too much debt.)

Anyhow, why are you still talking about public debt? Everybody knows Keynes said increase the public debt. You say that is the solution again, now. Other people say public debt was the problem then, and is the problem now. Nobody says fuckall about private debt. Get out of the box, Larry. This isn't 1936. The facts are different.

When events change, I change my mind. What do you do?

Fourth, the traditional suite of structural policies to promote flexibility are not especially likely to be successful in the current environment, though some structural policy approaches such as removal of restrictions on investment are still desirable. Indeed, in the presence of chronic excess supply, structural reform has the risk of spurring disinflation rather than contributing to a necessary increase in inflation. There is, in fact, a case for strengthening entitlement benefits so as to promote current demand.

IS, Larry. The traditional suite of policies IS not likely to be successful. If you're going to say it, Larry, at least get the grammar right.

Larry, Larry, Larry. First you say "some structural policy approaches such as removal of restrictions on investment are still desirable." Then you say "in the presence of chronic excess supply, structural reform has the risk of spurring disinflation". I know, when the facts change you have to change your mind. But you changed your mind mid-paragraph. The facts didn't have time to change.

And then, oh my: You say "There is, in fact, a case for strengthening entitlement benefits so as to promote current demand."

You're a case, Larry. You get things we need mixed up with policies we should put in place. Instead of doing something about income inequality, you would increase entitlements "to promote current demand". Have you forgotten what an economy is? Do you not know how an economy works?

And that brings us to your concluding paragraph:

There is much more to be said about policy going forward. But treatments without accurate diagnoses have little chance of success. We need to begin with a much clearer diagnosis of our current malaise than policymakers have today. The level of interest rates provides a very strong clue.

I absolutely agree that an accurate diagnosis is required. That's why I'm writing to you today, Larry. But that thing about interest rates, you have to re-think that.

You said it yourself: Interest rates are inconceivably low, and we must figure out what it means.

Here, let me lay it out for you Larry.

Interest rates are at record lows, and still going lower. You told me as much. The Fed wants to "normalize" rates -- wants to get rates back to normal. But markets don't expect a hint of normal till at least 2019.

Of course, if there is any hint of inflation, or any hint of vigor in the economy, rates will rise and cap off the vigor right away. Meanwhile, it's all downhill. You told me so.

We need to get interest costs down to get economic growth so that we can raise interest rates and undermine that growth. This is your plan for the economy. What's to understand?

Larry, you crack me up. All this focus on interest rates. And no focus at all on the number of dollars on which interest must be paid. You guys cut interest rates, as low as they can go. Now you're trying silly stuff with negative rates -- an act of desperation, to be sure. But you pay no attention to the accumulation of debt. It's the accumulation of debt that created the need for low rates.

Cut debt in half, Larry, and you cut interest costs in half. What's to understand?

Thoma

Marc Thoma:

Globalization and international trade were supposed to make us all better off. There would be adjustment costs along the way ... but in the long-run more trade would lift all boats. But that hasn’t happened.

The creation of the EU was a political solution to economic problems. It was sold to the voters as a solution to economic problems. It would make the economy better, the voters were told.

It didn't make things better. It didn't address the fundamental economic problems. It only opened a door to the increased consolidation and concentration of wealth.

The "new characterization" forecast

From the "new characterization" PDF from James Bullard at the St. Louis Fed:

The upshot is that the new approach delivers a very simple forecast of U.S. macroeconomic outcomes over the next 2½ years. Over this horizon, the forecast is for real output growth of 2 percent, an unemployment rate of 4.7 percent, and trimmed-mean PCE inflation of 2 percent. In light of this new approach and the associated forecast, the appropriate regime-dependent policy rate path is 63 basis points over the forecast horizon.

The PDF is dated 17 June 2016. Let's say the "next 2½ years" includes the second half of 2016 plus all of 2017 and 2018. The "new characterization" predicts real growth, unemployment, and inflation thru the end of 2018.

A footnote on "trimmed-mean PCE inflation" reads

We will refer to inflation as measured by the 12-month Dallas Fed trimmed-mean inflation rate throughout this memo as we think it is the best indicator of inflation trends. The most current reading is 1.84 percent.

Links:

http://www.dallasfed.org/research/pce/

https://fred.stlouisfed.org/search?st=Trimmed+Mean+PCE+Inflation+Rate

By "the 12-month ... inflation rate" I'm thinking they mean what FRED calls "Percent Change from Year Ago" (as opposed to the "Percent Change at Annual Rate" or the "6-Month Annualized Percent Change").

Yeah. The current vintage is dated 2016-06-29. The most recent previous vintage is dated 2016-05-31. The most recent value of this earlier vintage, for April 2016, is 1.84. Same as the reading in the footnote:

Graph #1: Seeing if I have the right data. Yup.

To be annoyingly fastidious, the "Percent Change at Annual Rate" series shows the value 2.48 for April 2016 in the May vintage. And the "6-Month Annualized" shows the value 1.91 for April, in the May vintage. The "Percent Change from Year Ago" series -- FRED's PCETRIM12M159SFRBDAL -- is definitely the one they used for the "new characterization" PDF.

//

So here in red is the inflation forecast -- 2.0 percent annual from July 2016 to the end of 2018:

Graph #2: The Inflation Rate (blue) and the Inflation Forecast (red)

Oh, I want to say it looks like the blue line is going to crash thru the red line some time in mid-2017,

about a year from now, before even the mid-point of the forecast period. But who knows.

If, if, and if

At Reddit: St. Louis Fed President, Jim Bullard, outlines new characterization of the outlook for the U.S. economy which criticizes forecasting more than 2.5 years into the future.

At the St. Louis Fed: The St. Louis Fed's New Characterization of the Outlook for the U.S. Economy by James Bullard, Cletus Coughlin, Bill Dupor, Riccardo DiCecio, Kevin Kliesen, Michael Owyang, Mike McCracken, Chris Waller, Dave Wheelock, and Steve Williamson.

From the blurb:

President James Bullard and his co-authors explain the St. Louis Fed’s new characterization of the U.S. macroeconomic and monetary policy outlook, which more explicitly takes into account uncertainty about possible medium- and longer-run outcomes.

Uncertainty.

The new approach is based on the idea that the economy may visit a set of possible regimes instead of converging to a single, long-run steady state.

Uncertainty about the future. Specifically: Perhaps "converging to a single, long-run steady state" refers to things like ... I don't have an example from the St. Louis Fed, but

CBO uses potential output to set the level of real GDP in its medium-term (10-year) projections. In doing so, CBO assumes that any gap between actual GDP and potential GDP that remains at the end of the short-term (two-year) forecast will close during the following eight years

the "single, long-run steady state" being the path of RGDP ten years out. Bullard says no more of this! Bully for you, Bullard!

As such, the new approach does not include projections for long-run values for U.S. macroeconomic variables or for the policy rate.

See? Less certainty.

Oh, heck, I really like this. Here's the whole blurb:

The PDF is The St. Louis Fed’s New Characterization of the Outlook for the U.S. Economy, nine pages.

From the PDF:

An older narrative that the Bank has been using since the financial crisis ended has now likely outlived its usefulness, and so it is being replaced by a new narrative. The hallmark of the new narrative is to think of medium- and longer-term macroeconomic outcomes in terms of regimes. The concept of a single, long-run steady state to which the economy is converging is abandoned, and is replaced by a set of possible regimes that the economy may visit. Regimes are generally viewed as persistent, and optimal monetary policy is viewed as regime dependent. Switches between regimes are viewed as not forecastable.

I just really like this. It is an admission they know less than they thought.

Under the heading WHY NOW in the PDF:

It is a good time to consider a regime-based conception of medium- and longer-term macroeconomic outcomes. Key macroeconomic variables including real output growth, the unemployment rate, and inflation appear to be at or near values that are likely to persist over the forecast horizon. Any further cyclical adjustment going forward is likely to be relatively minor. We therefore think of the current values for real output growth, the unemployment rate, and inflation as being close to the mean outcome of the “current regime.”

Of course, the situation can and will change in the future, but exactly how is difficult to predict. Therefore, the best that we can do today is to forecast that the current regime will persist and set policy appropriately for this regime.

Now is the time, they say, because inflation, unemployment, and real growth are "at or near values that are likely to persist" for the next two and a half years. This is interesting to me because they're not predicting recession within the next 30 months, and also because they and I disagree on the persistence of those current values. I expect growth to become vigorous within that time frame and unemployment to fall further, with inflation pressures reduced by the fall in the debt-per-dollar ratio since 2008. I've predicted vigor here and considered comparable vigors here.

The part about "the best that we can do" is straight out of Keynes:

In practice we have tacitly agreed, as a rule, to fall back on what is, in truth, a convention. The essence of this convention — though it does not, of course, work out quite so simply — lies in assuming that the existing state of affairs will continue indefinitely, except in so far as we have specific reasons to expect a change.

Continuing a thought in the WHY NOW section of the PDF:

If there is a switch to a new regime in the future, then that will likely affect all variables — including the policy rate — but such a switch is not forecastable.

It's not my area but this sounds to me very much like the uncertainty and ergodicity of which Syll writes so often.

//

Notes on Productivity:

We do not think of the current regime as “pessimistic.” Output grows at the trend pace of two percent, but the unemployment rate remains quite low, and inflation remains at two percent. In addition, as we will describe below, output growth could improve if productivity growth improves.

The new narrative views medium- and longer-term macroeconomic outcomes in terms of a set of possible regimes that the economy may visit instead of a single, unique steady state. By doing this, we are backing off the idea that we have dogmatic certainty about where the U.S. economy is headed in the medium and longer run. We are trying to replace that certainty with a manageable expression of the uncertainty surrounding medium- and longer-run outcomes.

The productivity growth rate has been low on average at least since 2011. We think of this as a low productivity growth regime. We know from past observation of the U.S. economy that productivity could switch to a higher growth regime. If such a switch occurred, it might have important effects on many variables, but especially on output growth, which would be higher.

If productivity growth improves. If such a switch occurs. I'm thinking they have no story about what drives productivity. I have a story about what drives productivity.

//

Other loose ends

We have described a situation in which Phillips curve effects on inflation are negligible. Low unemployment and generally strong labor markets, despite being in place throughout the forecast horizon, do not put upward pressure on inflation in the forecast we have described. It could be that meaningful Phillips curve effects return and drive inflation higher even though nothing else about the situation as we describe it has changed. This is one risk.

First, we have no reason based on current data to forecast a recession, and so we adopt a “no recession” baseline scenario.

///

If low productivity magically switches to high productivity ...
If meaningful Phillips curve effects magically return ...
If we are surprised by a recession ...

Something old, something new, something borrowed, something blue

Sorry, I couldn't resist that title.

The oldest and newest "vintages" of data for the series "Household Debt Service Payments as a Percent of Disposable Personal Income" at ALFRED:

Graph #1

What I expected? Maybe the data would go back some years before 1980 and I could use it to extend the current series back to an older start date.

What I got? Everything starts in 1980, so it doesn't do me any good. Plus, the two datasets don't match up at all.

Besides that, the difference varies:

Graph #2

The old series runs from more than 122.5% of the new series, down to about 111%, then quickly up, and down.

I wonder what accounts for the difference.

In How much income is used for debt payments? A new database for debt service ratios by Mathias Drehmann, Anamaria Illes, Mikael Juselius and Marjorie Santos (13 September 2015), the authors discuss the methodology of developing DSR data series:

... amortisation data are generally not available and hence present the main difficulty in deriving aggregate DSRs.

... it is possible to construct meaningful aggregate DSRs with a relatively sparse set of aggregate data ...

... potential mistakes mainly lead to a shift in the level of estimated DSRs, but will not affect their dynamics over time.

Potential mistakes mainly lead to a shift in the level of estimated DSRs, but do not affect their dynamics over time.

To me this means the numbers might all be high or might all be low, but the patterns of the high data and the low data should be quite similar. I think we see this in the graph. And yet, as the second graph shows, the patterns are not as similar as one might hope.

Debt service

I was never much of a reader, but I did read a book by John Barth one time, back in the days when I read things other than econ. Giles Goat-Boy it was called. The thing I remember is that Barth used the word "service" as you might use the word "rogering".


At FRED I search for debt service and select Household Debt Service Payments as a Percent of Disposable Personal Income (TDSP).

Debt Service Payments (DSP) as a percent of Disposable Personal Income (DPI). The calculation for that is TDSP=100*DSP/DPI. For some reason, FRED doesn't give DSP in billions -- or if they do, I can't find it. To get DSP in billions I have to convert back from percent of DPI using DSP=DPI*TDSP/100, thus:

Graph #1: Household Debt Service Payments in Billions of Dollars

I want to check this.

Debt service payments include both interest and principal. FRED provides a data series called Monetary interest paid: Households. This should be the interest portion of household debt service payments. Together on a graph, "monetary interest paid" should be less than debt service payments in billions. It is:

Graph #2: Household Debt Service (blue) and Monetary Interest Paid (red)

Monetary interest paid is consistently lower than debt service in billions. Plus, I see a satisfying similarity between the two. This graph gives me confidence in both my calculation and the monetary interest series.

I wonder how the red line compares to the blue when I take the ratio. Here is interest payments as a percent of debt service:

Graph #3: Household Interest Paid as a Percent of Household Debt Service Payments

Going down since 1983.

The interest portion falls from near 70% of debt service in the early 1980s, to less than 50% at present. So we know the "repayment of principal" portion increased, from near 30% to more than half of debt service. Falling interest rates probably had something to do with these changes. Okay.

You know... If we have debt service in billions, and we have the interest portion of it also in billions, then we can calculate the difference, the "principal repayment" portion of debt service. I never had that number before. Secrets are revealed!

Graph #4: The Principal Repayment Portion of Household Debt Service, in Billions of Dollars

Going up. No surprise there.

We can look at household debt principal repayment as a portion of household debt:

Graph #5: Principal Repayment as a Percent of Household Debt

Wandering. I want to say it is going down, but I see it trying to go up.

Repayment of principal falls during the first two recessions shown, and rises during the last two. Is this a change in behavior? Perhaps. It's gotta be more difficult to make those payments in times of recession. In the 1980s and '90s we were not so concerned about our debt, household debt. We let the principal payments fall before and during recessions. But since 2000 we seem to be more concerned about our debt: Repayment of principal increases during recessions.

A change like that could have a significant negative effect on economic growth.

One more graph.  Two more graphs. I want to compare principal repayment to the change in household debt. Why? Because if new borrowing is gaining on principal repayment, we're getting further behind.

Graph #6 shows a ratio (not a percent). When principal repayment and the change in household debt are approximately equal, the graph will show a value near 1.0. When principal repayment is greater, the value will be above 1.0. And when principal repayment is less, the value shown will be less than 1.0.

Graph #6: Principal Repayment relative to the Change in Household Debt

At first glance, the plot appears to run close to 1.0 from start-of-data to the start of our recent troubles. In other words, for all that time, since 1980, we were paying back nearly as much money as we borrowed. Things changed with the crisis, of course. But it appears that for 25 years or more we paid back amounts near equal to the amounts we borrowed. However, if you take a closer look, this first-glance conclusion does not hold up:

Graph #7: Principal Repayment relative to the Change in Household Debt (1980-2008)

I chopped off everything after 2008, where things started going crazy. You can see that the ratio reaches 1.0 just once, during the 1982 recession. Just less than 1.0, actually. In other words, even during that very severe recession, our new borrowing was more than we paid back.

The average repayment for the full period (2008 excluded) looks to be about 0.6, or 60% of the addition to borrowing.

So that means ... If we borrowed 100 we paid back about 60 so the net was ... no ... It means if the data says the change in household debt was 100, new borrowing was actually 100 + 60, and principal repayment was 60.

What that tells me, I don't know. But if every time I borrow $160 I only pay back $60, well, that's the how and why of debt accumulation. Roger that.

Real Growth versus Inflation

Syll links to Mankiw who links to a PDF by Alesina and Ardagna, who write:

As far as reduction of large public debts, the lesson from history is reasonably optimistic. Large debt/GDP ratios have been cut relatively rapidly by sustained growth. This was the case of post–World War II public debts in belligerent countries; it was also the case of the United States in the 1990s when without virtually any increase in tax rates or significant spending cuts, a large deficit turned into a large surplus... However, it would probably be too optimistic to expect another decade like the 1990s ahead of us; that kind of sustained growth would certainly do a lot to reduce the debt/GDP ratio, but the lower growth we will most likely experience will do much less. Inflation also has the effect of chipping away the real value of the debt, but it may be a medicine worse than the disease. While a period of controlled and moderate inflation would have the potential to reduce the real value of outstanding debt, pursuing such a strategy would

At that point the paragraph turns to garbage. Actually it's all garbage as it ignores private debt. But it got me thinking about debt and GDP in the post–World War II period and the 1990s. And about growth versus inflation, and which of the two might have done more to reduce the debt-to-GDP ratio. So I graphed the ratio of real GDP relative to the GDP Deflator. When the line goes up, real growth is greater than inflation. When the line goes down, inflation is greater.

Graph #1: Real Growth versus Inflation