Wednesday, September 20, 2017

Final definitions of Money and Credit

In an old PDF, Joe Salerno defines money: the final means of payment in all transactions.

At EconomicsHelp, Pettinger defines credit: any form of deferred payment.

These two definitions work. And they work together.

Tuesday, September 19, 2017

In case you don't get it...

David Beckworth, in The Knowledge Problem in Monetary Policy at Mercatus:

Inflation is caused by both supply and demand shocks. Monetary policy can only productively address the latter, but discerning which type of shock has caused inflation in a particular instance is almost impossible for Fed officials to do in real time.

In case you don't get it, Beckworth draws a picture:

See the two circles at the top of the picture? How do we know there are only two circles? It's an assumption. Maybe the picture should look like this:

What could be in that third circle? Here's a thought: policy. Maybe it's policy that's causing the inflation problem. And maybe the solution is not to tighten or loosen, but to try something else with the money. Something like keeping an eye on the ratio of credit to money.

Imagine that.

Monday, September 18, 2017

Beckworth gets it

Milton Friedman quoted JS Mill. I requote it often:

There cannot, in short, be intrinsically a more insignificant thing, in the economy of society, than money ... [Money] only exerts a distinct and independent influence of its own when it gets out of order.

Here's Friedman himself:

Money is so crucial an element in the economy, yet also largely an invisible one, that even what appear to be insignificant changes in the monetary structure can have far-reaching and unanticipated effects.

David Beckworth explains:

... money is the one asset that is a part of every transaction. Whether the transaction is the sale of a physical or financial asset, a good, or a service, money is always a part of the exchange. It reaches into every market. Consequently, destabilizing money destabilizes all markets.

"Money is the one asset that is a part of every transaction." Memorize that.

When a problem affects the whole economy, like inflation or unemployment for example, one of the first things to consider is the money: "Is there a problem with the money?" Always. Even if the problem appears quite certainly to be "peak oil" or "too much immigration" or "China".

Sunday, September 17, 2017


You know about the Fed's 2% target for inflation. Since 2012 I think, that's been the official target.

Thomas Palley, in 1996, in The Atlantic, wrote:

most economists support policies of zero inflation achieved by high real interest rates

Myself, I'm no economist. But I think economists should be embarrassed to support any inflation other than zero. I think they should see the call for 2% as an admission of failure -- a failure of policy, and of the theory behind it.

Anyway, it occurs to me that using high real interest rates to achieve an inflation target has the unintended consequence of increasing aggregate financial costs to the economy. Let's say unintended.

Imagine an alternative way to fight inflation. If we design and implement tax policy to encourage the accelerated repayment of debt, we have a new way to limit aggregate demand. But the new policy includes the intentional consequence of reducing aggregate financial costs to the economy. It may not seem that way now, because private debt remains at such a high level. But as the new policy pushes down debt-to-everything-else ratios, the effect will soon become clear.

Saturday, September 16, 2017

When Palley and Taylor agree...

I switched on a computer that had been off for six months, and found something I didn't remember putting on the desktop: The Forces Making for an Economic Collapse (subtitle: Why a depression could happen) by Thomas I. Palley in the July 1996 issue of The Atlantic.

That's July of 1996.

I was going to quote Palley where he says a new Great Depression has become possible -- 1996, remember -- because it shows remarkable foresight. Instead, I'll file that under Recommended Reading and move on.

Here, Palley describes policy shortly before the "Goldilocks years" of the mid-to-late 1990s were to become obvious in hindsight:

... the Fed now interprets any sign of wage increases as incipient inflation, and responds by raising interest rates. Since wage increases are the means by which labor shares in productivity growth, this policy is tantamount to helping corporate and financial capital to gang up on labor.

The Federal Reserve vividly illustrated its new stance in 1994, when it raised interest rates six times. Just as the long-awaited economic recovery was picking up steam, the Fed slowed employment growth. It claimed that its action was necessary to prevent inflation from accelerating, but never produced compelling evidence of the danger of inflation...

The story since December 2015 is similar.

Palley didn't know it in July of 1996, but the economy was strong enough then to withstand a series of interest rate hikes and move ahead with vigor nonetheless.

We don't know it yet, but the economy today is probably strong enough again to withstand a series of interest rate hikes and still move ahead with vigor. And strong enough for the same reasons.

One more quote from Palley to emphasize the similarity between the 1990 recession and recovery, and the 2009 recession and recovery. While the '90 recession was still fresh in his mind, Palley wrote:

Just as the causes of the 1990 recession have been poorly explained, so have its prolonged nature and the weakness of the subsequent recovery. Economists consider the recession to have ended in the first quarter of 1991, but substantive recovery did not really begin until the second half of 1993. Thus for almost three years the economy was effectively dead in the water.

Dead in the water. We know about that. For crying out loud, even John Taylor in 2016 was saying "In several key ways the US economy resembles an economy at the bottom of a recession, ready for a restart".

Friday, September 15, 2017

Credit is not the same as money (even if you can't see it)

David Glasner at Uneasy Money: Milton Friedman Says that the Rate of Interest Is NOT the Price of Money: Don’t Listen to Him!

In the days before the internet, I wrote to Milton Friedman three times. He wrote back every time. That was great.

Not only that, but I could tell from Friedman's answers that he read and understood what I said. That's a rare and precious thing. For this reason I will always think of Milton Friedman as a great economist, no matter how many problems I have with his economics.

David Glasner quotes Friedman, from the Friedman Heller debate:
... the interest rate is not the price of money... The interest rate is the price of credit. The price of money is how much goods and services you have to give up to get a dollar.

That's it. That's it exactly. I had written to Milton Friedman, and my explanation for what I was thinking was: the interest rate is the price of money. Friedman wrote back to me, saying the interest rate is not the price of money; the interest rate is the price of credit; the price of money is what you have to give to get the money.

I remember, because I had to think about it for years before it made sense to me. Literally, for years.

It made sense, finally, when I realized that credit is not the same as money. Here's how I see it: I can get money two ways. Either I work for it, or I borrow it. If I work, I help to build this civilization and the money is my reward. If I borrow it, I'm going to have to pay it back, with interest.

Credit is not the same as money. The idea came to me direct from Milton Friedman. Having embraced the idea, I can easily see people who have not taken that idea to heart. People like David Glasner, who writes:
What is wrong with Friedman’s argument? Simply this: any asset has two prices, a purchase price and a rental price. The purchase price is the price one pays (or receives) to buy (or to sell) the asset; the rental price is the price one pays to derive services from the asset for a fixed period of time. The purchase price of a unit of currency is what one has to give up in order to gain ownership of that unit. The purchasing price of money, as Friedman observed, can be expressed as the inverse of the price level, but because money is the medium of exchange, there will actually be a vector of distinct purchase prices of a unit of currency depending on what good or service is being exchanged for money.

But there is also a rental price for money, and that rental price represents what you have to give up in order to hold a unit of currency in your pocket or in your bank account. What you sacrifice is the interest you pay to the one who lends you the unit of currency, or if you already own the unit of currency, it is the interest you forego by not lending that unit of currency to someone else who would be willing to pay to have that additional unit of currency in his pocket or in his bank account instead of in yours.

I have a problem with that. Glasner says there is always a rental price for holding money. If it's money you borrowed, he says, the rental price is the interest you pay on the loan. If it's money you earned, money you "own" as Glasner says, there is still an opportunity cost for holding it, and this is its "rental price".

But if the dollar in my pocket is borrowed, I can still choose to lend it out and collect interest on it. If I fail to do that, then by David Glasner's logic I am paying the rental price twice for that dollar, once for interest, and again for the lost opportunity.

So, looking at it Glasner's way, if the dollar in my pocket is my own, I am paying the rental price which is an opportunity cost. But if the dollar in my pocket is borrowed, the rental price I pay is opportunity cost plus interest cost. The cost (or "rental price") of a borrowed dollar is different from that of a dollar I own. Therefore, a borrowed dollar is different from an earned dollar.

An earned dollar is "money". A borrowed dollar is "credit". The opportunity cost for holding money applies to both money and credit. The interest cost applies only to credit.

Milton Friedman was right: The interest rate is the price of credit. David Glasner cannot see it, because he has not embraced the idea that credit is not the same as money.

One more point. I want to leave out the "opportunity cost" part and look at the rest. Glasner says:
But there is also a rental price for money, and that rental price represents what you have to give up in order to hold a unit of currency in your pocket or in your bank account. What you sacrifice is the interest you pay to the one who lends you the unit of currency ...

Glasner says that in order to hold a borrowed dollar, I have to pay interest to the lender. That's incorrect. I don't have to pay the interest because I'm holding the dollar. I have to pay the interest because I borrowed the dollar! Look what happens when I finally spend that dollar: The fellow who receives that dollar does not have to pay interest on it. The interest obligation stays with the borrower.

The interest obligation is part of the same loan agreement that created the credit you could spend. That's what credit is: a "medium of exchange" dollar that moves through the economy, and a dollar of debt that stays with the borrower.

When you borrow a dollar you receive a dollar of money and a dollar of debt sandwiched together. When you spend it, you peel off the money layer, spend that part, and keep the rest. The borrower retains the debt. But the borrowed dollar, once spent, is freed of the debt obligation and is thereby transformed from credit to money.

Thursday, September 14, 2017

New Borrowing, minus Interest Paid (adjusted for inflation)

... changes in borrowing behavior have played a smaller role in the growth of household leverage than is widely believed. Rather, most of the increase can be explained in terms of “Fisher dynamics” — the mechanical result of higher interest rates and lower inflation after 1980.

The year-to-year change in household debt is a measure of the money households borrow into existence and spend into circulation. An increase in household debt is an injection of funds into the money used as a medium of exchange.

But, to state the obvious, an addition to debt adds to debt. And debt must be repaid with interest. Interest is a cost that takes money and moves it from the productive sector to the financial sector. While it remains in the financial sector, the money is not used as a medium of exchange -- not, at least, in the productive sector.

So we can say that an addition to debt increases the money available for spending, and interest payments reduce the money available for spending. If we take one year's addition to debt and subtract from it the payment of interest for that same year, we can calculate a "net change" in money available for spending due to household credit use. Figure it for a number of years, and we can make a graph showing the history of the net change over time.

But the values on such a graph will be influenced by the rate of inflation. The graph will be malformed because the rate of inflation varies. As we are thinking about growth, we must remove the inflation. We can remove it by the same calculation used to remove inflation from "nominal" GDP.

However, I want to use the CPI as the measure of inflation, rather than the Deflator, because we're looking at household debt and household interest costs.

All of this can be done at FRED with a minimum of fuss:

Graph #1: Net Change in the Medium of Exchange due to Household Debt

The description of the calculation (in the upper blue border of the graph) has been cut short by a devious and disappointing FRED. The full description is "(Households and Nonprofit Organizations; Credit Market Instruments; Liability, Level-Monetary interest paid: Households and nonprofit institutions)*(100/Consumer Price Index for All Urban Consumers: All Items)"
The plotted line shows the increase in debt, minus interest paid. The difference has been adjusted for inflation. Where the line is above zero, borrowing is greater than interest cost. Where the line is below zero, borrowing is less than interest cost.

Before 1980, the line is mostly above zero, indicating a net increase in the circulating medium, a boost for spending and growth.

Between 1980 and 2000 the line is mostly below zero, indicating a net decline in the circulating medium due to the cost of interest.

The graph supports JW Mason's statement.

Wednesday, September 13, 2017

It's not a coincidence

At Bloomberg: Act or Wait? Fed Debate Heats Up After Inflation Misses Target by Matthew Boesler, 13 Sept 2017.

The opening words:

Former Federal Reserve Chairman Alan Greenspan, in year nine of a U.S. economic expansion, conceded in 1999 that patience was sometimes a better policy than his doctrine of preemptive interest-rate moves because “the future at times can be too opaque to penetrate.”

For some Fed officials, these days look like one of those times to wait for clarity.

And this:

“The conventional wisdom did not work in the 1990s and it is not working now,” said Allen Sinai, chief executive officer of Decision Economics in New York.

The 1990s and now. It's not a coincidence.

Tuesday, September 12, 2017

The butterfly non-effect

The butterfly effect is a concept that states "small causes can have larger effects".

Macro events (in big economies) don't have micro causes

Scott Sumner has a tendency to say things clearly. For example:

I see the business cycle as being (in Fisher's words) a "dance of the dollar". Unstable monetary policy shows up as unstable NGDP. Since wages are sticky, employment tends to move with NGDP in the short run, and unemployment is countercyclical. Recessions occur when a sharp decline in NGDP growth leads to a rise in unemployment ...

In other words:

Monetary Policy --> NGDP Growth --> Employment Growth --> Recession

There's no place for butterflies there.

Like Sumner, I see monetary policy as causal. We differ because, for me, monetary policy should include not only money but also credit; and the credit-to-money ratio is of the utmost importance. But we agree that monetary policy is causal.

I also agree with Sumner (or, say Okun) on the relation of GDP growth and employment growth; and certainly recession may follow from changes in GDP and employment.

But where Sumner has NGDP Growth, I would instead put Spending Growth:

Monetary Policy --> Spending Growth --> Employment Growth --> Recession

I would have a second arrow coming out of Spending Growth, pointing to NGDP Growth on a different line. Other things would be pointing to NGDP Growth as well. Butterflies included.

Monday, September 11, 2017

Does not contradict my prediction of booming RGDP

Capacity Utilization is going up again:

Graph #1
(Does contradict those who expect recession within the next two years.)

Imagine the improvement possible if Capacity Utilization were to rise from 75% to 85 or 90 percent. Look at the size of the increases after the 1970 and '74 recessions. Such things are possible. Such things were possible, I should say. For us, too much, too soon.

Okay, so look at the increase after the 1991 recession: five percentage points. That would get us to 80% and (for those whose memories go back as far as 2008) that would seem pretty good. But 80% is still low: Look at the graph. We should expect to approach 85%, as in the 1980s and '90s.

And, because recent patterns of debt and debt service are comparable to those of the 1990s, we should expect a sustained high in capacity utilization and in economic growth, as in the '90s. Maybe longer, as the fall of debt was deeper and people are more cautious now about adding to their debt.

This would be the perfect time for policymakers to create tax incentives designed to accelerate the repayment of private debt.

Saturday, September 9, 2017

"Don't Look Now," Bloomberg says, "But Productivity Is Finally Rising"

At Bloomberg: Don't Look Now, But Productivity Is Finally Rising.

I told you so.

The Bloomberg post is date 7 September 2017.

On 17 November 2016 I explained Why Labor Productivity is Low, and said

We are in a transition now that will soon give way to a more vigorous economy. Debt Service is beginning to increase, and productivity will soon be on the rise.

On 21 August 2016 I looked at productivity (real output per hour) for 22 data items (five years plus) beginning in 2011Q1. The linear trend ran low (near 0.5 percent growth) and flat.

I looked also at the nine quarters from 1993Q1 thru 1995Q1. The linear trend ran low (near 0.5 percent growth) and flat. But during the nine quarters from 1995Q1 thru 1997Q1, the trend increased from 0.5 percent to nearly 3%. "You never know," I said.

"To my way of thinking," I wrote,

Graph #1 (our time) is very much the same as Graph #2 (the early 1990s). But I think we are at the end of Graph #2 and ready to start Graph #3 [productivity improvement]. That makes all the difference.

"Oh come on," you are saying. "Graph #2 shows only a couple years. Graph #1 shows almost six years. There's no comparison. The slump is endless this time."

It's not endless. That's the point. The quiet time before the vigor is longer this time -- about 2½ times as long, my guess. I'm telling you we are at the end of the quiet period. Soon we will see productivity start to climb, just as on Graph #3.

On 7 April 2016 -- almost a year and a half ago -- I said

I predict a boom of "golden age" vigor, beginning in 2016 and lasting eight to ten years. It has already begun. In two years everyone will be predicting it.

And on 3 March 2016, in We are at the bottom now, ready to go up, I said

This is not going to be your typical anemic recovery. This is going to be the full tilt, rapid output growth, rapid productivity growth, high performance boom.

I can't promise you it'll last long, because the level of debt is already very high. But it'll be a good one while it lasts.

On 7 September 2017, Conor Sen of Bloomberg said Don't Look Now, But Productivity Is Finally Rising.

Friday, September 8, 2017

Remember Alan Greenspan in 1995, talking about anecdotal evidence?

In the last year or two we've seen a lot of improvement in jobs and employment, and economists were confounded by it because inflation didn't accelerate. And now they talk about how the Phillips Curve is "broken". They refuse to consider the possibility that the kind of good economy we had in the latter 1990s could return.

Tim Duy at Economist's View, quoting Cleveland Federal Reserve President Loretta Mester:

... my current assessment is that inflation will remain below our goal for somewhat longer but that the conditions remain in place for inflation to gradually return over the next year or so to our symmetric goal of 2 percent on a sustained basis. These conditions include growth that’s expected to be at or slightly above trend ...

... the 70 percent confidence range for forecasts of PCE inflation one year ahead is plus or minus 1 percentage point, and a significant portion of the variation in inflation rates comes from idiosyncratic factors that can’t be forecasted. Indeed...


...forecasted. Indeed, since the 1990s, assuming that inflation will return to 2 percent over the next one to two years has been one of the most accurate forecasts.

Tim Duy responds:

Since 1990, a 2 percent forecast has worked more than not, so lets just stick with that as the baseline for policy? By that logic, since the great recession, a 1.75% forecast has worked more than not, a testament to the Fed's one-sided inflation target and falling inflation expectations. I am not buying into her inflation forecast story yet.

He's a pretty good read.

As Duy points out, the more recent inflation numbers have been lower. Thinking in terms of averages, if the average since 1990 is 2% and the average since 2009 is 1.75%, then the average for 1990-2009 must be higher than 2%. Thinking in terms of year-on-year results, this appears to be the case:

Graph #1: Core PCE Inflation (the Fed's measure of choice) since 1990

Looking at that graph, I just want to remind you that the latter 1990s were pretty good for employment and income and real GDP growth, not just for price stability. Economists consider that a fluke, though. They refuse to consider that it could happen again. In the last year or two we've seen a lot of improvement in jobs and employment, and economists were confounded by it because inflation didn't pick up as well. And now they talk about how the Phillips Curve is "broken". But they refuse to consider the possibility that the kind of good economy we had in the latter 1990s could come back.

Duy quotes New York Federal Reserve President William Dudley:

Overall, the economy remains on a trajectory of slightly above-trend growth, which is gradually tightening the U.S. labor market. Over time, this should support a rise in wage growth. When combined with [other] factors, that causes me to expect inflation will rise ...

See? Dudley cannot imagine that inflation will remain calm as the economy improves -- broken Phillips Curve or not. A repeat of the latter 1990s is inconceivable to him.

(President Dudley says he expects inflation to rise just to the Fed's target and stop there (at 2%) but doesn't say why. Not by natural causes, certainly. By aggressive rate hikes, should inflation attempt to exceed its target. Typical Fedspeak. Dudley isn't predicting inflation. He's threatening to act against it.)

Duy further quotes William Dudley:

But, the upward trajectory of the policy rate path should continue to be shallow, in part because the level of short-term interest rates consistent with keeping the economy on a sustainable long-run growth path is likely to be considerably lower than it was in prior business cycles.


Duy quotes more:

If it turns out that structural changes have played a significant role, I would generally view this as a positive, rather than negative, development. It would imply that the U.S. economy could operate at a higher level of labor resource utilization without generating a troublesome large rise in inflation. More people could be put to work on a sustainable basis, enabling them to gain opportunities not just to earn greater income, but also to develop their skills and grow their human capital.

And Duy says this suggests

a downward revision of estimates of the natural rate of unemployment.

Tim Duy is right.

Notice that Dudley mentions "structural changes" (but fails to identify the changes or their causes), says it's a good thing (ooh, ooh, maybe he can imagine that inflation will remain calm as the economy improves! Nah, it's probably just words). And the rest of the paragraph just gets giddy. Rather than explaining the fall of the natural rate of unemployment, he gives us the happy ending.

Duy again:

Separately, on the data front, we get this from Commerce, via Reuters:

The U.S. economy probably grew faster than reported in the second quarter, with data on Thursday suggesting stronger consumer spending than previously estimated.

The quarterly services survey, or QSS, from the Commerce Department implied consumer spending increased more briskly than the 3.3 percent annualized rate reported last week in its second estimate of gross domestic product.

The Fed forecasts are based on more modest growth numbers. Stronger growth numbers will tilt them toward further rate hikes.

Yup: If growth improves, policymakers expect inflation. They simply refuse to consider the possibility that the economy might actually be good for a few years.

Nobody remembers the Alan Greenspan of 1995, talking about anecdotal evidence and refusing to raise rates as the economy improved.

Wednesday, September 6, 2017

I'm with Menzie

From Demystifying the trade balance: Why a trade balance deficit isn't necessarily a sign of a poor economy at the FRED Blog:

Is it bad to have a trade account deficit? If this means that your economy is booming and local production cannot keep up with demand, then no. If it implies that there is a current account deficit and, hence, foreigners are investing in your country, then also no. If this means that you can have more investment without having to save more, because the rest of the world is picking up the slack, no again. If you are worried that in the future dividends will flow abroad, then yes. But that will happen only if your economy is in good shape in the first place and will be able to afford paying such dividends.

From US Withdrawal from KORUS Free Trade Agreement?

This is not to argue we couldn’t have more aggregate demand redistributed to the US — in my recent paper on global imbalances I argue that in fact it would be desirable for the US to have a smaller current account deficit.
Menzie Chinn

Friday, September 1, 2017

Paying down debt is a better way to fight inflation than raising interest rates

Why is paying down debt a better way to fight inflation than raising interest rates?

Paying down debt takes money out of circulation. Raising interest rates doesn't.

Paying down debt reduces financial costs. Raising interest rates increases them.

Paying down debt affects those who have borrowed. Raising rates affects everyone.

Paying down debt to fight inflation also reduces debt.

Reducing debt encourages growth. Raising rates discourages growth.

Paying down debt is a better way to fight inflation than raising interest rates.

Thursday, August 31, 2017

Same old story, but with an Arthurian ending

At Roubini's EconoMonitor, A New Banking Crisis? by Satyajit Das
Today, there are over $3 trillion in stressed loan assets, compared to around $1 trillion of US sub-prime loans which was the catalyst for the 2008/2009 crisis. The World Bank estimates the ratio of non-performing loans (“NPLs”) to total gross loans is comparable the 2009 levels of 4.2% in 2009.

Surprised? Not really.

It's a mess, the article says. Italian banks. German banks. India, China and Brazil. Developing economies, and advanced economies:

In developing economies, strong capital inflows, seeking higher returns or fleeing depreciating currencies, has encouraged increases in leverage. State policies encouraging debt funded investment or consumption to create economic activity has also led to banking problems...

In advanced economies, many banking systems are also large relative to the real economy. They are also vital in facilitating payments and supplying the essential credit that drives consumption, investment and government spending. Any disruption in financial intermediation quickly results in a real economic slowdown.

And again: "State policies encouraging debt funded investment or consumption... [and] the essential credit that drives consumption, investment and government spending."

You know how it works, right? We think credit use is good for economic growth, so credit use is encouraged by policy. It would happen anyway, but policy makes it happen all the more. So people borrow, and spend the money, and this spending is extra, on top of the spending that would have occurred naturally. And the extra spending leads to growth.

But there is more to the story: The extra borrowing leads to debt. Policy encourages borrowing, and borrowing creates debt. Policy makes credit use unnaturally common, so debt accumulates to an unnaturally high level. And as debt accumulates, the cost of debt increases. You know it's true.

Everybody worries about the Federal debt. Nobody worries about the non-Federal debt. Why is that?

The people who owe all that debt are unhappy about it and want to get rid of it. They don't need anybody telling them they have too much debt. They don't react well when you tell 'em.

The people who own all that debt and make money on it are happy about it and they don't want things to change. So they say private debt's not a problem. For them, of course, it's not.

But for us, it is a problem. And for the economy as a whole, it's a problem. So why can't we solve this problem? Because, for some reason, people seem to see debt as a personal problem, a problem of character and integrity and, dammit, I can pay down my debt, I'll just work a little harder.

Yeah, and you have to respect people for that. But what those people seem not to realize is that it's not all their fault. The system is rigged. The system is set up to get you in debt. The system encourages credit use.

It is policy to encourage credit use. It is policy to get you in debt.

Policy tilts the playing field to put us in debt. Sure, some of us can get out of debt. But not all of us can, because policy tilts the playing field. We'll never get out of debt, and we'll never get our economy out of debt, until we change policy.

The quick and dirty solution is to create new policies that encourage the repayment of debt. If we want to keep the policies that make debt grow extra-fast, then we need some offsetting policies that get us paying debt down extra-fast. That way, debt won't accumulate to an unsustainable level.

And these new policies shouldn't be punitive. Instead, they should help us pay down debt at a faster rate. At least until we get debt down to where the economy is good again.

PS: Paying down debt is also a way to fight inflation. A better way than raising interest rates.

Sunday, August 27, 2017

The power to change the world

By changing the tax code we could bring back Mom-n-Pop stores and put Walmart out of business. I'm not recommending it. But the tax code has power enough to make it happen.

At Digitopoly Joshua Gans takes a look at John Kenneth Galbraith's The New Industrial State, fifty years on.

Gans is one of those people who put conclusions first, without a fact in sight:

Galbraith’s book is worth revisiting, since its subject is back in the news. Like many people today, he was worried about unchecked corporate power. Yet with the benefit of hindsight, we can see his worries were largely wrong.

Largely wrong? Where did that come from?

The article had me screaming "NO" again and again -- each time reading on, to see if it backs up its assertions. In the end, Gans and I mostly agree. But we take very different paths.

There are two points Gans makes in the article that I want to consider. The first concerns corporate size:
You actually don’t have to read The New Industrial State to understand its story. Galbraith observed, as others had done before him, that ... key industries were dominated by few very large firms — and sometimes even just one...

Why were those firms so large? Galbraith’s answer was that they needed to be so because technology required large amounts of capital to be deployed — think your large auto assembly, oil refineries, and chemical plants.

Gans accepts Galbraith's answer and moves on immediately: "What did that mean? First, the owner-manager firms were not possible ..."

I don't move on with Gans. I scream "NO" and write a blog post.

"Why were those firms so large? Galbraith’s answer was that they needed to be so because technology required large amounts of capital to be deployed."

The economy didn't start there. It didn't start with "very large firms". Largeness developed over time. If largeness is the problem, then you can't start with largeness. You have to go back in time and consider the causes of the development of the largeness.

This is something economists fail to do all the time. They take the current situation as a "given" and move on from there. That's not how problems get solved.

"Galbraith’s answer was that they needed to be so because technology required large amounts of capital to be deployed."

But why did technology require large amounts of capital be deployed? Isn't that the key question?

Galbraith and Gans want us to accept the notion that technology simply required it. I don't believe that's true. In one of those Back to the Future movies they had a Mr. Fusion device on the Delorean. Mr. Fusion, like Mr. Coffee, small enough to fit on your kitchen counter or the trunk of your car. It's a great vision, one that offers hope for a better future where energy is cheap and accessible.

Do you think the future will turn out that way? I don't. If we ever get fusion working, we will end up with another "very large firm" that requires "large amounts of capital". It won't fit on your kitchen counter.

Kinda deflates the dream, doesn't it?

But if these companies didn't get "very large" they wouldn't require large amounts of capital. So the question is: Why do they get so big?

They get big because the tax code encourages it. The technology evolves to fit.

The second point I want to consider concerns economies of scale.
[Galbraith's] theory predicted that the most valuable companies would be those with the most revenue to spend on large capital investments and workforces. That turned out not to be the case. The winners today aren’t Galbraithian.

... We have not seen corporations grow in dominance as Galbraith predicted.

Thus the very foundation of The New Industrial State did not hold. But why? Here is my own conjecture: In 1967 the scale of the large, centrally planned U.S. corporation had largely reached its limit. After that point, growth required more than finding additional demand. Indeed, there is only so much you can get from modern marketing ... Eventually, further growth became more expensive, cutting into corporate profits.

Here, I agree completely with Gans. The large corporation had "largely reached its limit". Additional growth came at a higher cost. The "limit" reached was the limit set by economies of scale. It was no longer more profitable to get bigger. It was becoming less profitable to get bigger. And that was in 1967, when the economy was still good!

Back in the early 1980s, the late '70s maybe, I subscribed for a while to the Kiplinger Letter. I remember a fragment of one article where they were talking about agribusiness. They said agribusiness had "outgrown its economies of scale".

That was one of those things that strikes you, and it struck me so hard I still remember it today. How can a business grow beyond its economies of scale? Wouldn't it be better to split into two separate companies so both could grow more cheaply?

It would be better. It would be best for each company to be sized at its greatest economies of scale. That way each company would be most efficient and most profitable. A perfect world, so to speak. So why do businesses grow beyond the point that maximizes their economies of scale?

The tax code. The tax code encourages bigness.

No matter how big a business is, it can still reduce its taxes by sinking more of its profit into growth. When a business has grown beyond its economies of scale, the tax advantage for growth is still there, and the tax code subsidizes any inefficiency that results.

I agree with Joshua Gans and Kiplinger that businesses often grow beyond their economies of scale. I disagree with Gans and Galbraith that the technology drives business size. If a business by some magic was suddenly half its present size, and the tax code created the best advantage at this new smaller size, the firm would seek the technology best suited to that smaller size.

If most firms were most profitable at half their present size, they would split instead of merging, and technology would evolve to favor the smaller optimum size.

The tax code encourages bigness. It's a problem. In a perfect world, the tax code would encourage every business to reach its maximum economies of scale, and remain there. In this imperfect world the best we could do is let markets work: Eliminate the tax advantage for bigness, and let every business and every industry work out the size thing for itself.

Saturday, August 26, 2017

Where we stand

In March of last year I said We are at the bottom now, ready to go up.  I said:

This is going to be the full tilt, rapid output growth, rapid productivity growth, high performance boom.

We're still waiting. I know. But it's still mid-2017. That puts us just about midway between the start of 2016 and the start of 2019. I marked the current moment on this graph:

Graph #1: Markup of Graph #4 from mine of  3 March 2016
The prediction on the graph runs flat till just about now, and then begins the vigor.

Now consider this FRED graph, modified from a FREDBlog post:

Graph #2: Three Measures of RGDP Growth, March 2016 to August 2017
I modified the FRED Blog graph so it starts in March 2016 and ends at the current moment, August 2017. At the start, all three lines are midrange, between 1.5% and 2.0% growth. Then, for most of the graph, the lines contradict each other. But so far this year, the three lines are coming together and moving higher. It is a hint of better economic growth to come.

The FRED graph is compatible with my prediction. Can't see it? That's because I'm telling you early. If I waited until it was obvious, it wouldn't be a prediction.

Two of the three lines are running off the top of the plot window, and the third is headed in that direction. It's not exactly a consensus, but it is an indication. Note also that the top edge of the plot window shows a growth rate of 3.5%.

I'd like to remind Menzie Chinn that Trump was talking about 3.5% to 4% growth.

It won't be long. DJT will be telling us he has succeeded in making America "great again" because we got good growth. Don't believe it. We were going to get good growth anyway.

Thursday, August 24, 2017

Cheating for GDP

You know, you can find anything on the internet. Anything except useful information on immigration. Mine is a simple question: If immigration stopped in 1960, how would the US population number be different today?

Notice I said "population number". I'm not asking how the population would be different. This is not a question about ethnicity or race. It's a question about population size.

Anyway, I couldn't find the numbers I was looking for. But I did find this graph at

Graph #1, from Yale Essay Says Sustainability and Open Immigration are Often at Odds
The treehugger article (from 2009) says

A recent essay in YaleGlobal online by Joseph Chamie explores the controversial connection between immigration and overpopulation—a subject that is constantly framed morally or economically, but rarely environmentally.

The graph takes "no immigration" back to the early days of our nation, which doesn't serve my purpose. And there is no data file. But suppose we take the two numbers shown for 2009: A population of 307 million (actual) versus 127 million (with no immigration). With no immigration the U.S. population would have been less than half the actual 2009 population.

San Fransisco Fed President John C. Williams says

Over the medium term, the sustainable growth rate of the economy equals the sum of productivity growth and the growth rate of labor supply.

Over the longer term, labor supply growth will still play a key role in economic growth. Without immigration, the U.S. population would be less than half the size it is today. The U.S. labor force would be less than half the size it is today. And U.S. Real GDP would be less than half the size it is today.

You can look at it the other way: Because of immigration, Real GDP today is more than twice what it would have been with natural population growth. So you could say immigration allows us to boost economic growth. But that strikes me as cheating: Getting more economic growth by adding more people is not the same as getting more economic growth by increasing productivity.

Real GDP goes up because of immigration, but Real GDP per capita does not. We're not better off when immigration makes GDP go up. There are more of us demanding slices of the bigger pie. It's not like we all get bigger slices. As Nick Rowe put it, the country

becomes twice as big. Everything scales up in proportion. The supply of everything doubles, and the demand for everything doubles, so all prices (and wages) stay the same...

Wages don't double. Wages stay the same.

Or maybe demand doubles, but the supply of everything doesn't double because there are limits to growth. That pushes prices up. And because immigration accelerates population growth, the labor supply increases faster than the demand for labor. That pushes wages down. This is not the best of all possible worlds.

Anyway, it's cheating. Using immigration to increase GDP is cheating. Increasing productivity is the only way to go.

Wednesday, August 23, 2017

Low productivity is evidence of inadequate growth, not the cause of it.

Productivity is output per hour. That's how you figure productivity. You take a number like Real GDP and divide it by the number of hours worked in the year the output was produced. That gives you output per hour.

Then you want to see how much it changes from year to year. So you figure "percent change from previous year" or something similar. We know technology is advancing. We expect the economy to grow. So we assume there will always be some improvement. We assume the percent change in productivity will always be greater than zero.

When economists say productivity has been low, they are simply saying that there hasn't been much improvement.

But productivity is a way to measure the growth of output. That's all it is.

When somebody in a position of power says something, people listen. Somebody like John C. Williams of the San Fransisco Fed. So, when John C. Williams tells us there is "a global productivity slowdown" that is "fundamentally redefining achievable economic growth", we listen. We figure he must know what he's talking about. But either Williams doesn't know what he's talking about, or he dumbed it down way too much.

A slowdown in productivity, he says, is reducing the amount of economic growth we can get.

A slowdown in productivity is lowering growth? No. Productivity is a measure of economic growth. First, you get the economic growth that you get, and second, you evaluate it in terms of productivity. If productivity is down, it is because economic growth is down (unless there were big changes in Total Hours Worked, which would be suspicious). If productivity is up, it is because economic growth is up. (Ditto.)

Set aside the changes in Total Hours Worked, and just look at output per hour worked. That's the true measure of improvement. Productivity.

So how do you increase productivity? Easy: You increase output. When output goes up, output per hour goes up. It's true by definition, since we set aside the changes in hours worked.

John C. Williams asks a different question: How do you increase output? And his answer is the reverse of mine: You increase productivity, he says.

But productivity is measured as output per hour. You cannot make productivity go up unless output goes up. It's true by definition.

When John C. Williams says the slowdown of productivity is reducing economic growth, he has things exactly backwards. Low productivity is evidence of inadequate growth, not the cause of it.

Tuesday, August 22, 2017

Thumbs up, Nick

At Worthwhile Canadian Initiative: Thinking about Costs and Benefits of Immigration. Nick Rowe sets up a scenario:

The country clones itself and becomes twice as big. Everything scales up in proportion. The supply of everything doubles, and the demand for everything doubles, so all prices (and wages) stay the same...

It's an economic model of a nation enlarged by immigration. Then Nick considers the costs and benefits of immigration in the following areas:

  • Money and Say's Law.
  • Land.
  • Capital.
  • Economies of Scale.
  • Non-Rival Goods.
  • National Debt and Assets.
  • Comparative Advantage.
  • Productivity and Terms of Trade.
  • Redistributive Taxation.

After that, Nick considers one additional area -- "All The Other Things" -- and says:

If a doubling of the population caused a civil war, because the immigrants and original population had incompatible visions of how the country should be governed, that would obviously be a cost to the original population. And that cost might outweigh or nullify any of the other possible benefits listed above.

It doesn't have to be civil war. At the start, it might only be a growing discomfort. Nick's observation stands: This one immigration-related cost might outweigh all the benefits.

When economists talk about immigration they always talk of economic quantities: income, labor, employment, demand. They always talk about how these quantities will be affected. But they never talk about the nation itself, how the nation is affected, the society, and the culture.

The costs to the nation, the society and the culture may be the greatest costs of all.

Monday, August 21, 2017

Or maybe you can't depend on it

"Arthurian" economics is the economics that makes sense to me; nothing more, nothing less. Supporting it is the understanding I have of everybody else's economics. And it's all, or almost all, just things I've picked up because I'm interested.

It's not always easy figuring out what other people are thinking. It wasn't long ago, for example, I finally learned that when you see a graph of a supply curve or a demand curve, output is on the horizontal axis and price is on the vertical.

Anyway, price is always on the vertical axis. Knowing that is almost always useful, when you read somebody's offhand remark. Not knowing it, sometimes the remark cannot be understood. Knowing it, you know what the guy is saying.

So here we are, and I'm looking at flat phill in Google Search, and I find Broken Phillips Curve a Symptom of Lower U.S. Inflation Expectations from PIMCO. They show this graph:

Graph #1, from PIMCO

They have it backwards. They have price on the horizontal.


Sunday, August 20, 2017

It's a small thing, but you can depend on it

One more thing from Christopher Snyder's VOX article What economists study: A guide for the curious:
How is value determined? Scholars puzzled over this for a long time. Why are diamonds, mere decorations, so prized, while water, essential for human life, flows freely from public fountains? In the Middle Ages, philosophers advanced the just-price theory...

Today, economists generally believe that value is neither inherent, nor determined by a single factor, but is the result of the interaction of several impersonal market forces. We can explain the water-diamond paradox simply by drawing curves of supply and demand, as depicted in Figure 2. Seller behaviour is represented by the red supply curve. Its upward slope indicates that at higher prices, more is supplied as existing suppliers expand their operations and new suppliers are drawn into the market. Buyer behaviour is represented by the blue demand curve. Its downward slope indicates buyers are willing to purchase more at lower prices.

Figure 2 Market supply and demand

An equilibrium is reached where supply and demand intersect. At other points, either supply exceeds demand, leading price to fall as sellers accepted lower prices to offload their excess inventory, or demand exceeds supply, leading price to rise as buyers would still line up to buy at higher prices rather than do without the good. Equilibrium price P* determines the object’s value.

Note that the vertical axis shows "price". On a graph like this, the vertical axis always shows price. Price, or inflation, or wages. Always some measure of money, on the vertical scale.

Maybe they taught that the first day in Econ One, I dunno. If they did, I missed it. But if you don't know price is on the vertical axis, things they say about the graph won't make sense. Especially when they just talk about the graph and never actually show it.

So now we know.

Saturday, August 19, 2017

Two points from "What economists study"

At voxeu, What economists study: A guide for the curious by Christopher Snyder.

Took me a while to get around to reading this, because it didn't strike me as "economics". I mean, if economists can give us things like the Global Financial Crisis, then surely economists are not studying the right things. But when I sat down to read it, I liked it. I liked it even though Snyder writes:

One of the great advances of modern empirical economic research is causal identification—uncovering true causal relationships rather than overinterpreting apparent correlations as causation.

Maybe that's what I do, overinterpret apparent correlations as causation. I look at graphs and try to find things that are similar and things that are dissimilar. But hey, I have my theories, and my theories are based on historical data, and that's good enough for me. I'm no economist, and I can't do the kind of math economists do, "causal identification" and all that, but economists are welcome to use that stuff on my theories any time they want. Meanwhile, there are a couple points in Snyder's article that I want to mention.

1. The Just-Price Theory

In the Middle Ages, philosophers advanced the just-price theory. This argues that value is an inherent property of an object. On this view, diamonds are expensive because of their inherent quality, and water is not.

What a cute idea! Gold isn't valuable because it's rare. Gold is inherently valuable.

Nobody thinks like a Middle Ages philosopher these days, except those who think money should be backed by something that has intrinsic value.

2. Feedback from the Economy

Economists have to devise clever ways to establish causation in nonexperimental data. Pick one ... A macroeconomist might pick Romer’s (1992) study of whether fiscal or monetary policy deserved more credit for the US recovery from the Great Depression. The problem: a bad economy can feed back to make beneficial policies look damaging.

A bad economy can feed back to make beneficial policies look damaging. Yeah, exactly, and that's very important. There is another version of the same idea: A good economy can make any policy (good or bad) look good.

There are techniques that rely on such ideas. A common one is to separate the good economy from the bad and study only the bad years. Any study that starts in 1980 or after, ignoring the "golden age" that followed WWII, is one of these. There must be millions of 'em.

Friday, August 18, 2017

Wise words

Tim Duy:

This is the language used by the far right to discredit and undermine faith in our government institutions. For the left to adopt the same language adds to the fire already burning.

Thursday, August 17, 2017

Stop doing psychology and start doing econ

Brad DeLong:

[M]ore than a generation of inequitable and slower-than-expected economic growth in the global North has created a strong political and psychological need for scapegoats.

Well fuck you Brad DeLong. For inventing stories about my psychological need for scapegoats, fuck you.

DeLong continues, regardless:

People want a simple narrative to explain why they are missing out on the prosperity they were once promised, and why there is such a large and growing gap between an increasingly wealthy overclass and everyone else.

I can give you the simple narrative: Excessive private debt is the reason we are missing out on the prosperity we expect, and excessive private debt is the reason there is such a large and growing gap between an increasingly wealthy overclass and everyone else. End of narrative.

If Brad DeLong would stop doing psychology and start doing econ, he could see it for himself.

Wednesday, August 16, 2017

Too much fertilizer

The Symptoms of Over-Fertilizing:

Fertilizing plants encourages healthy growth and flowering, but too much leads to problems.

Some signs of over-fertilizing are easy to spot... And though fertilizer should encourage healthy growth, too much can stunt growth or stop it entirely.

Is it possible that the emphasis on free trade and globalization is just too much fertilizer?

Tuesday, August 15, 2017

Voluntary vs Involuntary Unemployment

Pettinger ("helping to simplify economics") offers this definition:

Voluntary unemployment is defined as a situation where the unemployed choose not to accept a job at the going wage rate.

That's it exactly. And by choosing to define voluntary rather than involuntary unemployment, Pettinger simplifies economics. Here is Keynes:

If, indeed, it were true that the existing real wage is a minimum below which more labour than is now employed will not be forthcoming in any circumstances, involuntary unemployment, apart from frictional unemployment, would be non-existent. But to suppose that this is invariably the case would be absurd.


Moreover, the contention that the unemployment which characterises a depression is due to a refusal by labour to accept a reduction of money-wages is not clearly supported by the facts.


For, admittedly, more labour would, as a rule, be forthcoming at the existing money-wage if it were demanded.

In other words, involuntary unemployment is a situation where the unemployed are willing to accept a job at the going wage, but do not find work. This meshes perfectly with Pettinger's definition.

And then there is Scott Sumner:

We all agree that there were lots of people without jobs. We all agree that lots of them wanted to be working. We all agree that lots of them were miserable. I call that “involuntary unemployment.”

Number one, Sumner gets the definition of "involuntary" unemployment wrong. It's not about being out of work. (That's just "unemployment".)

Number two: I omitted it, but Sumner prefaces these thoughts by saying, "But what is so obvious about involuntary unemployment, as defined by Keynes?" That's Sumner's emphasis on the words "as defined by Keynes", not mine.

The first three sentences after those four words all start with the phrase "We all agree". Sumner apparently agrees with Keynes three times. But he is putting words in Keynes' mouth, as we find out in the next sentence after, where Sumner admits he has been giving us his own definition of involuntary unemployment.

But Sumner's is not a definition of involuntary unemployment. It is only a definition of unemployment: without a job, wanting work, and miserable. And it's not even a technical definition of unemployment. It's just some social chatter.

"Involuntary unemployment" is a technical term, defined by Keynes. Pettinger simplifies the concept by choosing to define voluntary employment instead: a refusal to accept work at the going wage.

Funny thing: Sumner gets that wrong, too. He says:

I think they were unemployed because of sticky wages, and that if workers collectively accepted lower wages then we would have had full employment in 1936.

The Depression drove wages down, so that the "going" wage was lower during the Depression than before. Sumner is saying workers refused to accept the going wage (in 1936) because it was lower. This refusal, by definition, makes the unemployment in Sumner's story voluntary. Sumner calls it involuntary. Sumner is wrong.

Keynes establishes the definition:

The classical school [argue] that if labour as a whole would agree to a reduction of money-wages more employment would be forthcoming. If this is the case, such unemployment, though apparently involuntary, is not strictly so ...

Pettinger simplifies it:

Voluntary unemployment is defined as a situation where the unemployed choose not to accept a job at the going wage rate.

It's not complicated. Sumner is wrong.

Monday, August 14, 2017

I hate politics

Replying to Mark Thoma, I wrote:

Half a dozen years back there was so much right-wing chatter about the threat of inflation (from quantitative easing) that it seemed the chatters wanted hyperinflation, just to show they were right about the economy.

... It's not quite so bad these days, not yet at least, and I'm not sure it's only a left-wing phenomenon, but these days the chatter seems to be about impending recession.

Why would "impending recession" be a left-wing phenomenon?

Why, indeed. On the day after the Presidential Inauguration last January, Adam Ozimek was at Forbes with The Best Case For The Trump Economy. Ozimek is not a fan of Trump, as his concluding remarks indicate:

So if everything goes smoothly and Trump doesn't do anything crazy, or anything really, he could potentially keep the current pace of job growth running for a few more years and maybe even for the whole term...

If I was Trump, I'd do the absolute minimum policy-wise and make job #1 avoiding a recession.... I'd also probably change the hairdo.

Not a fan, but not so full of hate for the man that he can't do econ. Many people are.

Anyway, in the same article Ozimek says

If you look over the long-term, the employment to population rate falls during recessions then slowly recovers. So if we can avoid a recession, it's not crazy to think we could get back to 2000 levels.

I quoted that yesterday, talking about Trump's 4% growth target. Ozimek's point is that for Trump to succeed in making America's economy great again, he's going to have to avoid recession.

And there, right there, is the reason the chatter about impending recession is a left-wing phenomenon.

Sunday, August 13, 2017

Trump's 4% growth target

Trump apparently wussed out, abandoning his 4% target for economic growth and embracing 3%. I read a couple things ridiculing him at 3%, as if even that is too high a target. Absurd.

Myself, I'd hold Trump to his original target: 4%. We can get there. Even if we don't make it, shooting for 4% is a much more honorable goal than shooting for 3%. And far more impressive, if we make it.

Back in January 2017, Menzie Chinn of EconBrowser looked at Trump's growth target. Quoting from the economy page of the Trump-Pence website, Chinn echoes

Boost growth to 3.5 percent per year on average, with the potential to reach a 4 percent growth rate.

The Trump-Pence link today reports a "page not found" error. Wuss.

Anyway, Menzie points out that reaching Trump's growth target will require a large increase in the size of the labor force or in labor productivity, or both. Unrealistically large, Chinn implies. He says

it seems unlikely to have acceleration of growth to the indicated rates, especially if policies are undertaken to deport some portion of the population


If we are deporting undocumented workers en masse, how is [the labor force] going to be expanded?

It's a fair question.

At Forbes (21 Jan 2017) Adam Ozimek said

If you look over the long-term, the employment to population rate falls during recessions then slowly recovers. So if we can avoid a recession, it's not crazy to think we could get back to 2000 levels.

Ozimek continues:

That means going from 78.2% today to 81.9%, an increase of 3.7 percentage points. If you apply this to the 125 million population, that's about 4.6 million jobs. If these jobs take the whole four years of the Trump administration to recover, that's 95,000 jobs a month above and beyond the natural growth in the labor force. When you add in that natural labor force growth, that should be enough to keep job growth in the range from the last three months, which has averaged 165,000.

That was January. Job growth in June 2017 surged "as employers surpassed the expectations of most economists by adding 222,000 jobs."

As that kind of job growth continues, Trump's 4% becomes more likely.

At FiveThirtyEight (4 August 2017) Ben Casselman writes:

Meanwhile, the U.S. doesn’t seem to be running out of available workers, at least not yet. Rather, the improving job market seems to be drawing people off the economy’s sidelines. The labor force grew by 349,000 people in July; the so-called participation rate — the share of adults who are either working or actively looking for work — has been essentially flat for the past year and a half. That’s an impressive trend given the ongoing retirement of the baby boom generation, which puts downward pressure on the participation rate.

Things are happening in the labor force.

// Related: You don't just show a graph and assume that the trend it shows will continue forever

Saturday, August 12, 2017

Defining Aggregate Demand Deficiency

Nick Rowe defines Aggregate Demand Deficiency: "It means that the stock of money is too small, or is circulating too slowly, to buy and sell all the things that people want to buy and sell."

It sounds like Nick is saying the velocity of circulation of money is not influenced by the decisions of spenders. I would say it is the decisions of spenders that determine the velocity of circulation.

Suppose Nick accepts the view that spenders determine the velocity of circulation. How does that fit into his definition?

"There are too few spenders, or they are spending too slowly, to buy and sell all the things that people want to buy and sell."

But "people" are the spenders.

"People are spending too slowly to buy all the things that they want to buy."

So it seems people are confused, wanting to buy things but not wanting to spend the money.

Most of us are familiar with that problem, I think. And if we want something but decide not to spend the money, demand is reduced because of our decision. Our wants and desires only count as demand if we actually spend the money.

Nick Rowe's definition again: The stock of money is too small, or is circulating too slowly, to buy all the things that we want to buy.

"Want to buy" is not quite right. Everybody wants a coach and six, Adam Smith said. Everybody wants a Corvette. But not everybody gets one. All of that "wanting" is not demand.

Okay, so maybe 1000 people were actually going to buy Corvettes but it turns out that only 750 of them can afford to buy one. There is a demand shortfall of 250 Corvettes, 1000 minus 750. The million people who "want" Corvettes do not come into the calculation at all.


That definition again: An "aggregate demand deficiency" happens when money is circulating too slowly to buy all the things that people want to buy.

But of course we can always just go out and borrow the money, and buy whatever we want. But maybe we don't want to borrow enough to get that new Corvette. Or maybe our bank is telling us we don't want to borrow that much.

An aggregate demand deficiency might happen because we are borrowing less. And that's not really the same as "the stock of money is too small, or is circulating too slowly". It is, and it isn't. Borrowing money is a way to make the quantity of money bigger (if you count bank money as money) or it is a way to make the velocity of circulation increase (if you don't). But borrowing money has other effects also: It makes our debt bigger. It makes our debt service bigger. It reduces our "after debt service" income. It reduces the money we'll have in the future for spending to buy all the things that we want to buy.

In the long run, borrowing money creates an aggregate demand deficiency. The U.S. economy slowed after 1973? Aggregate demand deficiency since 1966. But we ignored it and kept borrowing anyway, borrowing more and more, because policy paved the way for that. And then, after 2007, we didn't keep borrowing anymore. And suddenly the stock of money was too small and we had ourselves an aggregate demand deficiency we couldn't ignore. As a consequence of borrowing and of the effects of too much borrowing for too long a time.

We borrowed too much, early on (in the 1950s and '60s). It became a problem in the 1970s. They fixed the problem in the 1980s and '90s by making it possible for us to borrow even more. But they solved the wrong problem. The problem was not that we couldn't borrow all that we wanted. The problem was the growing cost of the growing debt. They tried to solve the problem by encouraging us to add even more to our debt.

Borrow more we did. Add to our debt, we did. Debt grew faster and faster. But the overall cost of that debt grew also. And paying the debt service took money away from "aggregate demand" and created an "aggregate demand deficiency". And the economy grew slowly because of it.

But all that ended after 2007, when people suddenly realized their debt was a problem. And people started borrowing less and paying back more. And the economy suddenly tanked.

So here is the big picture: In the early years we have too much borrowing (but not a lot of debt) so aggregate demand is high and economic growth is good. In the middle years we have too much borrowing (and too much debt) so we have an aggregate demand shortfall that slows the economy despite all the borrowing. And in the later years we have no borrowing (and still too much debt) and the economy tanks.

So there is a little more to the story than "the stock of money is too small, or is circulating too slowly". There is also the cost of finance.

Friday, August 11, 2017

A weapon against the nation-state

Economic Theory: Limitations and Biases at Conversable Economist, 6 July 2017:

Arnold Kling tackles the hardy perennial topic "How Effective is Economic Theory?" in the Summer 2017 issue of National Affairs. His overall approach is to focus on "five interlocking subjects in particular: mathematical modeling, homo economicus, objectivity, testing procedures, and the particular status of the sub-discipline of macroeconomics." He then compares and contrasts what economists were saying about those subjects in 1966 and 1980, compared with his views on current patterns. For details, read the essay! But here are few excerpts that caught my eye and may give some flavor of his discussion:

"Economists are not without knowledge. We know that restrictions on trade tend to help narrow interests at the expense of broader prosperity. We know that market prices are important ...

There is a lot more, excerpts from Kling and thoughts on the excerpts. I want to cut it off right at the start and deal with the first piece of knowledge presented: Restrictions on trade tend to help narrow interests at the expense of broader prosperity.

It is a general statement, offered as something more than a rule of thumb. A lot more than a rule of thumb: Restrictions on trade are costly. Period, end of story.

It is presented as a given. Something economists know, and know for sure.

I have trouble with the period, the given, the certainty. But most of all, I have trouble with the incompleteness of that particular piece of knowledge. When the "narrow" interests are those of nations and the "broader" prosperity is that of global corporations, that harmless little piece of knowledge becomes a weapon against the nation-state.

How do the world's biggest companies compare to the biggest economies?

How will they compare when government is small enough you can "drown it in a bathtub"?

Thursday, August 10, 2017

Gotta love that focus on interest rates

From Bridging the Gap: Forecasting Interest Rates with Macro Trends, an FRBSF Economic Letter by Michael D. Bauer:

... interest rates affect household finances, business funding costs, government debt, and ultimately the health of the overall economy.

Yup. And everybody focuses on interest rates. But nobody worries about the size of accumulated private debt, which is the money on which interest has to be paid. Public debt, too; but if I didn't specifically say "private" you'd think I meant only the public debt. (Public debt is the least of our worries, or anyway the lesser.)

Wednesday, August 9, 2017

"the largest effect of the mortgage deduction is on household financial decisions, inducing them to increase indebtedness"

From the NBER access page for Do People Respond to the Mortage Interest Deduction? Quasi-Experimental Evidence from Denmark by Jonathan Gruber, Amalie Jensen, and Henrik Kleven:

Using linked housing and tax records from Denmark combined with a major reform of the mortgage interest deduction in the late 1980s, we carry out the first comprehensive long-term study of how tax subsidies affect housing decisions. The reform introduced a large and sharp reduction in the mortgage deduction for top-rate taxpayers, while reducing it much less or not at all for lower-rate taxpayers. We present three main findings. First, the mortgage deduction has a precisely estimated zero effect on homeownership. This holds even in the very long run. Second, the mortgage deduction has a sizeable impact on housing demand at the intensive margin, inducing homeowners to buy larger and more expensive houses. Third, the largest effect of the mortgage deduction is on household financial decisions, inducing them to increase indebtedness. These findings suggest that the mortgage interest deduction distorts the behavior of homeowners at the intensive margin, but is ineffective at promoting homeownership at the extensive margin and any externalities that may be associated with it.

(emphasis added)

The mortgage interest deduction encourages the growth of debt. We could have instead a policy that offers a tax benefit for making an extra payment or two during the tax year. Such a policy would discourage the growth of debt. And it could be designed to offer approximately the same tax benefit as the existing policy.

Tuesday, August 8, 2017

Parallel lines of thought

Douglas Campbell shows a graph I've not seen before -- total nonfarm employment "now something like 23% below the long-run trend" -- and says

Of course, there are caveats here. Population growth did naturally slow a bit, and the absorption of women into the labor force was a one-time event that was mostly played out by the 2000s; 9/11 exogenously reduced immigration, and thus job growth, and the Boomers have been retiring, etc... [But] why should exogenous negative shocks to labor supply cause wage growth to slow?

They shouldn't. As if in answer to Campbell's question, J.W. Mason writes

If employment is falling due to demographics, that should be associated with rising productivity and wages, as firms compete for scarce labor.

Monday, August 7, 2017

Explanation versus evidence

The reddit title caught my eye: Intangible capital making output gap & Phillips curve irrelevant? There is a good opening:

Here’s my thesis upfront: The growing dematerialization of capital accumulation has material consequences for financial markets and for the conduct of monetary policy: It helps to explain why there is a corporate savings glut that contributes to ultra-low interest rates, and why time-honored concepts used by generations of economists such as the output gap and the Phillips curve are becoming increasingly, well, immaterial.

Next, they explain what they mean by "immaterial":

Our economy is becoming ever more intangible. A rising share of our consumption is services rather than tangible goods. And to produce these services and goods, firms nowadays typically invest more in intangible capital than in physical capital. New ideas generated by smart people, patents, copyrights, brand, software and cloud space matter more than bricks and mortar, machines and inventories. In short, production processes are dematerializing – more sales are generated with less physical capital.

This caught my interest. Not because it's right, particularly -- it's way too soon to make a judgement call like that -- but because I never heard the story before. New ideas are rare and precious, even when they might be wrong.

It caught my interest. So I kept reading:

A growing body of research suggests that the progress of intangible capital has been the most important fundamental driver of the secular uptrend in corporate cash holdings over the past few decades...

Sentences like that unfailingly fool me into thinking I'm seeing evidence. However, such sentences are only stories about evidence; the conclusions they reinforce remain unsupported.

The paragraph continues:

The reason is that, unlike physical capital, intangible capital cannot easily be pledged as collateral for loans.

This sentence does not present any of the evidence we've just been told about. Rather, it plunges deeper into the story, giving us a "reason" for "the progress of intangible capital". Please note: I'm not saying it's all bullshit. I like the story, despite myself. It's just that, on second read, I'm seeing a story supported by explanation rather than evidence. So far, it remains only a story.

The rest of the paragraph builds on the unsubstantiated analysis:

Therefore, to maintain the financial flexibility to invest in intangible capital – spending more on R&D, buying start-up companies with smart people and products, acquiring or developing brands and patents, investing in artificial intelligence etc.—firms optimally hold larger cash balances. Of course, other factors, such as a U.S. tax system that only taxes corporate profits generated abroad once they are repatriated, also contributes to swelling (foreign) cash holdings. However, the dematerialization of capital investment seems to be the single biggest factors explaining the corporate savings glut.

As I say, it's a good story. And here's how the next paragraph starts:

This corporate savings glut, along with a higher desire by private households to save more in the face of rising longevity and with strong demand for safe assets from emerging economies, is the main reason why the natural or equilibrium rate of interest is very low.

Wow, see? It even explains why the natural rate of interest is so low. (Told ya it was a good story!)

But, well, the corporate savings glut, I've heard of that. And the strong demand for safe assets. And of course the low natural rate of interest. I am not yet sure how these factors fit my own economic theory, but at least I've heard of them.

But I never heard of the "higher desire by private households to save more in the face of rising longevity". Never saw a story about a connection between longevity and savings. It seems to make sense, yes, but it's just a story. One small piece of a larger story. But this storybook connection is something I can actually look at: Is it true that increasing longevity has brought a rise in the personal saving rate?

FRED says No:

Graph #1: Life Expectancy and Personal Saving
Life Expectancy and Personal Saving run in opposite directions. When life expectancy was low, the saving rate was high and rising. As life expectancy went up, the saving rate turned and went down. And now life expectancy is high and the saving rate is low, try as it might to increase.

So I don't see "a higher desire by private households to save more in the face of rising longevity". I can easily believe there is a higher desire to save, a desire that is never actualized. But if it doesn't show up in the numbers, it's only a story.

By putting longevity and saving together in a single thought, they gave me a relation to look at. So I looked. And, hey, I looked at only the one graph. But it's not there. The relation is not there.

I tried to participate. I went looking for evidence. I tried to confirm one little thing they told me. The FRED graph contradicts the story. So I lost interest in the story they tell, because it's only a story.