Thursday's Child

Thursday's graph shows the rate of base money growth (less the cost of growing it) in blue. And in red, the growth rate of Real GDP. I see similarity in the two lines, and I see differences that I can explain.

To that graph I added (in gray) the rate of base money growth with nothing subtracted from it.

Graph #1

I'd want to compare gray and red directly (without the interference of the blue) to say this with certainty, but looking at Graph #1 I don't see much similarity between gray and red. I don't see much similarity between base money growth (with nothing subtracted) and real GDP growth.

This graph only strengthens the visual similarity of Thursday's red and the blue.

// for completeness:

Just quickly, with the blue line removed:

Graph #2

Yeah, no, I don't think so. Maybe if we put inflation back into the red line?

Graph #3

It's your call.

Base Money Growth less the Cost of Base Money, and Real GDP

Yesterday's graph showed the FedFunds rate minus the rate of Base Money growth. It went up before every recession. Now I want to turn that graph upside down. I'm taking the rate of Base Money growth, and subtracting the FedFunds rate. So now the blue line goes down before every recession.

Then I added the growth rate of Real GDP to the graph, in red:

There are a couple highs on yesterday's blue line (lows today) that don't lead to recessions -- one in the mid-1980s, and one in the mid-1990s. But looking at the red line here, you can see that real GDP growth actually did slow down in those periods (though in the mid-1990s, oddly, the real growth lows came first).

But more interesting than that...

Think of the blue line as "net" base money growth. Think of the red line as showing real economic growth. Until the mid-1980s, the best real economic growth (red) was well above the fastest base money growth (blue). After the mid-1980s, the best real economic growth is well below the fastest base money growth. (And the graph doesn't show Quantitative Easing!)

So before the mid-1980s, the economy was willing to grow even if base money growth was weak. But since that turning point, the economy has been unwilling to grow even when base money growth is strong.

I'd say that's a significant change. What could have caused a change like that?

My guess would be our growing reliance on credit. The increased use of credit required a faster growth of the monetary base in the late years. But the cost of accumulating debt hindered growth of the real economy. That would be my guess.

When the FedFunds rate is above the Base Money growth rate, we go to Recession

Let's suppose that base money growth follows bank money growth. That's what you think, right? Okay, let's go with that.

If the FedFunds rate rises above the rate of base money growth, recession looms.

Dystopia#Economics

Wikipedia's Dystopia#Economics:

Economics

The economic structures of dystopian societies in literature and other media have many variations, as the economy often relates directly to the elements that the writer is depicting as the source of the oppression. However, there are several archetypes that such societies tend to follow.

A commonly occurring theme is that the state plans the economy, as shown in such works as Ayn Rand's Anthem and Henry Kuttner's short story "The Iron Standard". A contrasting theme is where the planned economy is planned and controlled by corporatist and fascist elements. A prime example of this is reflected in Norman Jewison's 1975 film Rollerball. Some dystopias, such as that of Nineteen Eighty-Four, feature black markets with goods that are dangerous and difficult to obtain, or the characters may be totally at the mercy of the state-controlled economy. Such systems usually have a lack of efficiency, as seen in stories like Philip Jose Farmer's "Riders of the Purple Wage", featuring a bloated welfare system in which total freedom from responsibility has encouraged an underclass prone to any form of antisocial behavior. Kurt Vonnegut's Player Piano depicts a dystopia in which the centrally controlled economic system has indeed made material abundance plentiful, but deprived the mass of humanity of meaningful labor; virtually all work is menial and unsatisfying, and only a small number of the small group that achieves education is admitted to the elite and its work. In Tanith Lee's Don't Bite the Sun, there is no want of any kind - only unabashed consumption and hedonism, leading the protagonist to begin looking for a deeper meaning to existence.

Even in dystopias where the economic system is not the source of the society's flaws, as in Brave New World, the state often controls the economy. In Brave New World, a character, reacting with horror to the suggestion of not being part of the social body, cites as a reason that everyone works for everyone else.

Other works feature extensive privatization and corporatism, where privately owned and unaccountable large corporations have effectively replaced the government in setting policy and making decisions. They manipulate, infiltrate, control, bribe, are contracted by, or otherwise function as government. This is seen in the novels Jennifer Government and Oryx and Crake and the movies Alien, Avatar, Robocop, Visioneers, Idiocracy, Soylent Green, THX 1138, WALL‑E and Rollerball. Rule-by-corporation is common in the cyberpunk genre, as in Neal Stephenson's Snow Crash and Philip K. Dick's Do Androids Dream of Electric Sheep? (as well as the film Blade Runner, loosely based on Dick's novel).

Not "As if people were replicants." No.

Peter Dorman:

You may feel a gnawing discomfort with the way economists use statistical techniques.  Ostensibly they focus on the difference between people, countries or whatever the units of observation happen to be, but they nevertheless seem to treat the population of cases as interchangeable—as homogenous on some fundamental level.  As if people were replicants.
You are right.

Maynard Keynes:

In dealing with the theory of employment I propose, therefore, to make use of only two fundamental units of quantity, namely, quantities of money-value and quantities of employment. The first of these is strictly homogeneous, and the second can be made so. For, in so far as different grades and kinds of labour and salaried assistance enjoy a more or less fixed relative remuneration, the quantity of employment can be sufficiently defined for our purpose by taking an hour’s employment of ordinary labour as our unit and weighting an hour’s employment of special labour in proportion to its remuneration...

If Peter Dorman is rejecting homogenous treatment, he is rejecting Keynes. Come to think of it, he is also rejecting Adam Smith:

In that early and rude state of society which precedes both the accumulation of stock and the appropriation of land, the proportion between the quantities of labour necessary for acquiring different objects seems to be the only circumstance which can afford any rule for exchanging them for one another. If among a nation of hunters, for example, it usually costs twice the labour to kill a beaver which it does to kill a deer, one beaver should naturally exchange for or be worth two deer. It is natural that what is usually the produce of two days or two hours labour, should be worth double of what is usually the produce of one day's or one hour's labour.

Simplicity

I drool over this crap, you know? I really do. It's far beyond what I can understand, to be sure. So I skip along the surface. I try to remember my limits, and always try to allow for the fact that there is more going on than I have figured out.

But look: If you can't explain it simply, you probably don't understand it.


I followed a Reddit link to Lies that economics is built on at Lars P. Syll.

Syll praises economist Peter Dorman and quotes a good chunk. Here's just a bit:

You may feel a gnawing discomfort with the way economists use statistical techniques. Ostensibly they focus on the difference between people, countries or whatever the units of observation happen to be, but they nevertheless seem to treat the population of cases as interchangeable—as homogenous on some fundamental level. As if people were replicants.

You are right, and this brief talk is about why and how you’re right, and what this implies for the questions people bring to statistical analysis and the methods they use.

I think that's crap. I think i//

Maybe I misunderstand completely, as Dorman writes of "statistical techniques" and it's a good bet I don't know what that is. But I think Dorman is attacking the macro in macroeconomics. Treating the population as "interchangeable" or "homogenous"...

I have no qualms about taking some total number -- debt or savings or output or whatever I happen to be looking at -- and dividing it by some other total number. If this other number happens to be population, then you could say I'm looking at debt or savings or output (or whatever) for the "average" person.

It doesn't invalidate the numbers simply because you can throw the word "average" at me. Dividing by a number is a way to provide context. That's what "GDP per capita" is, for crying out loud: GDP in the context of population. Or debt. I'm big on debt. So maybe I will look at debt per capita. You could say I'm looking at the average debt per person, and accuse me of high stupidity, and reject everything I've ever done because of it. But if you did, it would be YOU that was talking in terms of "the average" person. Not me.


Syll, by the way, presents a little cartoon graphic of somebody walking drunkenly on a busy highway, with this caption:

The state of the drunk at his AVERAGE position is alive

and this follow-up:

But the AVERAGE state of the drunk is DEAD

Don't just laugh at it. Try to figure out what it means. I think it's crap.


I followed Syll's link to Peter Dorman's Regression Analysis and the Tyranny of Average Effects. From Dorman's opening:

What follows is a summary of a mini-lecture I gave to my statistics students this morning.  (I apologize for the unwillingness of Blogger to give me subscripts.)

You may feel a gnawing discomfort with the way economists use statistical techniques...

You are right...

Our point of departure will be a simple multiple regression model of the form

y = β₀ + β₁ x₁ + β₂ x₂ + .... + ε

where y is an outcome variable, x₁ is an explanatory variable of interest, the other x’s are control variables, the β’s are coefficients on these variables (or a constant term, in the case of β₀), and ε is a vector of residuals.  We could apply the same analysis to more complex functional forms, and we would see the same things, so let’s stay simple.

I'm all for simple. The subscripts work if you put _{before and} after the text you want subscripted. As for Dorman's formula, he makes it simple until the end where he says

ε is a vector of residuals.

I don't know what that means. A set of error values maybe, one for each β? No matter, I'm not doing the calculation.

Here's a skip along the surface of the rest of Dorman's post:

What question does this model answer?  It tells us the average effect that variations in x1 have on the outcome y...

This model is applied to a sample of observations...

Now what is permitted to differ across these observations?  Simply the values of the x’s and therefore the values of y and ε.  That’s it...

Thus measures of the difference between individual people or other objects of study are purchased at the cost of immense assumptions of sameness...

So what other methods are there that make fewer assumptions about the homogeneity of our study samples?  The simplest is partitioning subsamples...

When should you evaluate subsamples?  Whenever you can...

A different approach is multilevel modeling.  Here you accept the assumption that y, the x’s and structural methods are the same for everyone, but you permit the β’s to be different for different groups...

Third, you could get really radical and put aside the regression format altogether.  Consider principal components analysis...

In the end, statistical analysis is about imposing a common structure on observations in order to understand differentiation...

Simple enough for ya?

It's not for me. I prefer the simplicity of Keynes:

The National Dividend, as defined by Marshall and Professor Pigou, measures the volume of current output or real income and not the value of output or money-income. Furthermore, it depends, in some sense, on net output... But it is a grave objection to this definition for such a purpose that the community’s output of goods and services is a non-homogeneous complex which cannot be measured, strictly speaking, except in certain special cases...

The difficulty is even greater when, in order to calculate net output, we try to measure the net addition to capital equipment; for we have to find some basis for a quantitative comparison between the new items of equipment produced during the period and the old items which have perished by wastage... The problem of comparing one real output with another and of then calculating net output by setting off new items of equipment against the wastage of old items presents conundrums which permit, one can confidently say, of no solution.

Thirdly, the well-known, but unavoidable, element of vagueness which admittedly attends the concept of the general price-level makes this term very unsatisfactory for the purposes of a causal analysis, which ought to be exact.

Nevertheless these difficulties are ... “purely theoretical” in the sense that they never perplex, or indeed enter in any way into, business decisions and have no relevance to the causal sequence of economic events, which are clear-cut and determinate in spite of the quantitative indeterminacy of these concepts. It is natural, therefore, to conclude that they not only lack precision but are unnecessary...

In dealing with the theory of employment I propose, therefore, to make use of only two fundamental units of quantity, namely, quantities of money-value and quantities of employment.

Now, that's more like it.

Reading tealeaves

Beep...
Beep...
Beep...

I'm backing up. Back to Tuesday's post where I quoted Cullen Roche from comments below William Vickrey’s 15 Economic Myths Debunked at Prag Cap.

But hold on now. It's not Vickrey's 15 Myths. It's Vickrey's debunking. Just to be clear on that :)

Roche opens the post, dated 16 September 2014, with these words:

This is an oldie but a goodie. William Vickrey was a Canadian economist and Nobel Laureate. He was well known for being critical of most things out of the Chicago School of Economics. This piece on 15 economic fallacies has been largely ignored, but the lessons are important and certainly as relevant today as they were in 1996 when Vickrey wrote them.

"... Largely ignored ..."

In some circles, maybe. I want to point out that Vickrey's debunking was brought to our attention more an three years ago by our very own nanute:

... an interesting working paper from the late Bill Vickrey on economic fallacies... Pay close attention on what he has to say about inflation and employment.

Oh. Yeah, I'm sure Prag Cap has more readers than The New Arthurian Economics. No doubt Cullen made a bigger dent in the ignorance of Vickrey's work than we did here. But that only means that Prag Cap's readers should have been coming here first....

But, to the point: The oldest comment on Cullen's Vickrey post is from tealeaves who writes:

If we look at the monetary interest paid on debt as a percentage of GDP, we see that the total interest paid on debt is recent lows (currently at 15%). Monetary interest peaked in 80s at 30% (the series doesn’t start at that point). The drop in monetary interest fell to 15% largely because interest rates have fallen since the 80s. And this drop in in monetary interest occurred even though the aggregate debt levels as a percentage of GDP have risen. (TCMDO/GDP).

http://research.stlouisfed.org/fred2/graph/?g=lZV

Obviously when interest rates rise, this “steals” away from corporations future profits or from consumers disposable income. This situation is probably not a problem for a long while if rates are low (below the 4% range). But because TCMDO (total credit) increases as at faster rate then GDP, isn’t here a potential for “crowding out” by monetary interest stealing more and more of future production as rates and total debt rises?

Yes, absolutely, yes.

I've said many times that interest costs, profit, and wages compete with each other for dollars of income. A dollar that goes to wages doesn't go to profit. A dollar that goes to interest doesn't go to wages or profit. You just have to look at the economy as Adam Smith did in Book I Chapter VI: Of the Component Parts of the Price of Commodities. Look at shares of income.

I prefer to say interest "competes" with wages and profits. But "steals" does get the point across. And tealeaves' description of interest costs "crowding out" wages and profit is exactly right.

Now, how does Cullen Roche respond to tealeaves? He evolves a bit. Cullen starts out rejecting the idea:

Interest is just another form of income.

But then he thinks about it for a moment:

If interest rates rise substantially then someone is earning a high income from this and someone is paying a higher fee for holding money.

He's being honest with himself, and a detail slips into his brain. "This doesn't necessarily 'crowd out' anything," he writes,

but I guess it could if it causes undue pressure on any particular sector (like the household sector when housing prices began to decline in 2006).

Yes indeed: "undue pressure". I guess you could get undue pressure if there was excessive reliance on credit, say. Only, it's not "pressure". It's a shift of income out of wages and into interest. It's a shift of income out of the productive sector and into the financial sector.

Excellent work, tealeaves! You opened Cullen's mind.

"Interest is just another form of income."

In comments at Prag Cap, Cullen Roche:

Interest is just another form of income. If interest rates rise substantially then someone is earning a high income from this and someone is paying a higher fee for holding money. This doesn't necessarily "crowd out" anything, but I guess it could if it causes undue pressure on any particular sector (like the household sector when housing prices began to decline in 2006).

Interest is just another form of income.

Yeah, interest is the form of income that is paid to finance. As opposed to wages (paid to labor) and profit (paid to capital).

Gene Hayward asked me something a few days back... Geesh, like three weeks ago:

Is the "Capital" referred to by you and all the other sources only "Physical" capital or does it include "financial" capital or "finance" as you refer to it often?

Basically, the question is: What is capital?

That question rolled around the back of my mind for a while, and I think I finally have an answer.

If I take some of my income and spend it, that's not capital. Maybe I buy lunch with that money. It's a good lunch, and a fair trade. I got what I paid for. And I don't expect to get my money back. I am such a good consumer!

If I take some of my income and save it, that's not capital. Maybe I put it into a simple savings account. Maybe I put it in a more complicated savings account with a fancy name. Either way, I'm saving. I say my money's "in the bank". I don't know where the money is, really. But I do have a claim on it and I can get it back (perhaps only after a delay or after paying a "penalty" of some kind).

If I take some of my income and use it in a way that there's a good chance my money will come back to me, that's capital. This differs from saving because when I save I'm not using the money. It differs from what I called "spending" because when I spend I don't ever expect to get the money back.

//

If I put my money into saving of some kind, that's "finance". If I put it into productive activity of some kind, that's "capital". That's the difference.

One dumb SOB

Excerpts from What Really Ended the Great Depression by Stephen Moore:

In a previous column I unmasked the historical lie that Franklin Roosevelt’s New Deal programs ended the Great Depression. After seven years of New Deal-era explosions in federal debt and spending, the U.S. economy was still flat on its back, and misery could be seen on the street corners. By 1940, unemployment still averaged a sky-high 14.6 percent. That’s some recovery.

However, I’ve been deluged with the same question from readers: Ok, what did end the Great Depression? Again, the history books get this chapter of history wrong. Most history books tell us that it was government spending on steroids to mobilize for World War II after the Japanese attacks on Pearl Harbor on Dec. 7, 1941.

In the 1940s, government spending did indeed surge. The federal share of gross domestic product (GDP) rose from less than 12 percent in 1941 to more than 40 percent in 1943-45. In other words, almost half of everything that was produced in the nation was to fight the war. Domestic spending on many FDR New Deal programs in education, training and social services dropped more than 90 percent.

The real issue is what caused the economy to surge after the war was over.

Here’s what happened. Government spending collapsed from 41 percent of GDP in 1945 to 24 percent in 1946 to less than 15 percent by 1947. And there was no “new” New Deal. This was by far the biggest cut in government spending in U.S. history. Tax rates were cut and wartime price controls were lifted. There was a very short, eight-month recession, but then the private economy surged.

Here are the numbers on the private economy. Personal consumption grew by 6.2 percent in 1945 and 12.4 percent in 1946 even as government spending crashed. At the same time, private investment spending grew by 28.6 percent and 139.6 percent.

The less the feds spent, the more people spent and invested. Keynesianism was turned on its head. Milton Friedman’s free markets were validated.

In sum, it wasn’t government spending, but the shrinkage of government that finally ended the Great Depression. That’s what should be in every history book — but isn’t.

Yeah, there was a lot of government spending during World War Two. Just like there is a lot of government spending now, okay, fine, sure.

Yeah, the government spending fell like crazy in the transition to a peacetime economy. Just like Stephen Moore wants government spending to fall like crazy now.

Stephen Moore would have us believe that the fall of government spending is what really ended the Great Depression. Stephen Moore is an ass. Do you want to know what happened, that prepared the economy for a generation of vigorous growth? It's very simple. Let me show you: