Spin-off #5

In spin-off #4 I used David Glasner's phrase "liquidity services", thinking it means the things liquidity can do for you. Never gave it a thought. When I read #4 later, the phrase stood out as something undefined. It makes sense to me that it refers to the things liquidity can do for you. But I don't know what Glasner was thinking. So I have to deal with this small matter even though it is a small matter indeed.

(By "liquidity services" I do not mean the company of that name or the services provided by that company. In addition, my intent is to mean not what I mean by the phrase, but what Glasner means, as my purpose is to evaluate his thinking without imposing my meanings upon his words.)

In his Price of Money post, Glasner says every asset has two prices, one to buy it and one to rent it. Then he defines the "rental price" as

the price one pays to derive services from [an] asset for a fixed period of time.

Later, when he applies the concept of rental price to money in particular, he makes a parallel statement:

the price that one has to pay ... to derive the liquidity services provided by that unit of currency.

So I don't think Glasner uses the term "liquidity services" to mean anything other than the useful things you think liquidity can do for you in some situation. He could as easily have said "the price that one has to pay ... to derive the liquidity" provided by the money. So I think my interpretation of "liquidity services" is adequate. And now I can evaluate Glasner's remarks:

You don't have to "derive" liquidity services from money. If you have the money, you have the liquidity. If you have the liquidity, you can do the things that having liquidity allows you to do.

If you have the money, everything else takes care of itself.

David Glasner and clearness of mind

Been lookin at Glasner's "price of money" post from September of last year: Milton Friedman Says that the Rate of Interest Is NOT the Price of Money: Don’t Listen to Him! Actually, my three posts since 15 December are all spin-offs from the response I'm writing to Glasner's post. Count this one as number four.

Glasner says

So although the interest rate is in some sense the price of credit, it is, indeed, also the price that one has to pay (or of which to bear the opportunity cost) in order to derive the liquidity services provided by that unit of currency.

"In order to derive the liquidity services" of money, he says. It's not right. When I receive a dollar, it comes with the liquidity services attached. That's what makes it money: you can spend it. You don't pay extra for liquidity services. They come with the money.

That's why you can "part with liquidity for a specified period." Because when you have the money, you also have the liquidity, and if you lend out the money the liquidity goes with it.

When Glasner says the interest rate is the price you have to pay "in order to derive the liquidity services" of your money, he is talking fluent gibberish.

The rate of interest, Glasner says, "is the cost of holding money". But it's not. The rate of interest is the opportunity cost of not lending money. And it should be the other way around, and it needs two extra words: The opportunity cost of not lending money is equal to the rate of interest. That's as close as I can get to what Glasner said, and still believe I have it right.

"Lending" money is an action. "Holding" money is not an action, not a transaction. "Holding" money is what happens between transactions. If we all "hold" all our money, there can be no transactions, no economy, no GDP, and no income.

It's lending that's the action in this case. It's lending or not lending that's the choice. Clearness of mind on this matter is best reached, perhaps, by thinking in terms of decisions to lend (or to refrain from lending) rather than of decisions to hold money.

Evolution of the standard description of money

I took Econ 101 Macro in the mid-1970s, in the midst of the Great Inflation. At the time, the identifying characteristics of money were still presented as

• medium of exchange
• store of value, and
• standard of value

The first of these identifies money as something we use and accept as payment. The second says the value of money doesn't change, or doesn't change much. So that if you don't spend a dollar today, it will have approximately the same purchasing power tomorrow or next week or next year. The third is how we identify money in words: "the dollar" for example.

Today the definition of money is slightly different. According to Merriam-Webster, money is defined as

something generally accepted as a medium of exchange, a measure of value, or a means of payment

The first of these is unchanged since the 1970s. And the third is rephrased but retains essentially the same meaning. The second, however, is different. No longer a reliable store of value, money is now a "measure" of value.

A "measure" of value rather than a "store" of value, because we now acknowledge that the value of the dollar changes. We now acknowledge inflation.

Is this change an improvement? I say no, it is not. It is good of course to to be honest with ourselves and admit that inflation changes the value of the dollar. But look at this graph from Robert Sahr:

The graph shows that relative price stability was possible over the long term, at least until the Great Depression. This being the case, it is wise to admit that the dollar is no longer the good store of value that it once was. But it is foolish to change the definition of money.

It would be better to hold to the old definition, and admit there is some problem with the "store of value" characteristic of money. That characteristic has changed, yes. But the problem is not that our definition went bad. The problem is that there is something wrong with the economy. A good solution would be to figure out what went wrong before it's too late. It isn't quite as simple as "printing money causes inflation".

Circulating relative to Sedentary money

Graph #1: Circulating Money as a Percent of Sedentary Money

When the line is going down, circulating money is going down, relative to sedentary money. And sedentary money is going up, relative to circulating.

When the line is going down, money is moving into savings.

People like it when they can save money. So it seems like a good economy when the line is going down. But only as long as it can keep going down. And there's the problem.

The line fell rapidly to the late 1960s, then went flat, and then we had a recession.
The line fell rapidly in the early 1970s, then went flat, and then we had a recession.
The line fell rapidly in the mid 1970s, then went flat, and then we had two recessions.
You could say those recessions were caused by the Fed, fighting the inflation. And I'd say: Sure. But it shows up anyway in the ratio of circulating-to-sedentary. Just like it shows up in yield curve inversion.

So the long-term trend was down, meaning less money was buying things and more was in savings, until the mid 80s. Then it went up a little in the mid-80s, and then the economy was good in the latter 80s.

And it went up a lot in the early 1990s, and then the economy was good in the latter 1990s.

But the line was low again by the year 2000, and then it went even lower, and then we had a "great" recession.

Aint that great?

And yes, the line has been coming up ever since. And when it gets high enough, it'll start to fall, and the economy will be good again for a while.

Opportunity Lost

You can't be in two places at once. That's a fact. But it's not a cost.


"Opportunity cost", from Wikipedia via Google:

In microeconomic theory, the opportunity cost, also known as alternative cost, is the value of a choice, relative to an alternative. When an option is chosen from two mutually exclusive alternatives, the opportunity cost is the "cost" incurred by not enjoying the benefit associated with the alternative choice.

See how they put the word cost in quotes? That's because opportunity cost is not really a cost.


I Googled the word cost. Not as a verb or action word, but as a noun, it means:

an amount that has to be paid or spent to buy or obtain something.

Straightforward, simple, and obviously correct.

In homage to relevance, I Googled define cost in economics. Wikipedia again:

Economic cost is the combination of and losses of any goods that have a value attached to them by any one individual. Economic cost is used mainly by economists as means to compare the prudence of one course of action with that of another.

Prudence. Dear prudence. Because every act is a "rational" act in economics. And every man is rational, everyone is prudent. But have you looked at the world lately? The world of politics for example, your world: No one is rational in that world. No one. It's easy to see it on the other side, not so easy to see it on your side. But both sides suffer this impairment of vision and this evidence of irrational behavior.

Under "People also ask" on that same page, from BusinessDictionary.com:

What is the definition of cost in economics?
An amount that has to be paid or given up in order to get something. In business, cost is usually a monetary valuation of (1) effort, (2) material, (3) resources, (4) time and utilities consumed, (5) risks incurred, and (6) opportunity forgone in production and delivery of a good or service.

and from EconomicsDiscussion.net:

What is the concept of cost?
In general terms, cost refers to an amount to be paid or given up for acquiring any resource or service. In economics, cost can be defined as a monetary valuation of efforts, material, resources, time and utilities consumed, risks incurred, and opportunity forgone in the production of a good or service.

See it? The word "forgone". The phrase "opportunity forgone". That's not the same as a cost.

I looked up "forgo". Seems to me there should be an "e" in that word, but Google tells me otherwise. Anyway: To "forgo" something means to do without it, like I have to do without the "e". You can see it as a cost if you want to, or maybe somebody can bullshit you into thinking it means "cost". It doesn't.

Go back to the definition of opportunity cost I quoted up top:

In microeconomic theory, the opportunity cost, also known as alternative cost, is the value of a choice, relative to an alternative.

And in particular, the sentence that comes next:

When an option is chosen from two mutually exclusive alternatives, the opportunity cost is the "cost" incurred by not enjoying the benefit associated with the alternative choice.

The phrase "mutually exclusive" means you cannot pick two things; you have to pick one or the other. However, the one you give up is not a cost. The simple fact is that you can only pick one of the two.

So you pick the one you want, knowing full well that you must forgo the other. But it's not a cost. So it's not an opportunity cost.

It's just an opportunity lost.


Cost is not hypothetical. Not imaginary. Cost is actual monetary cost: I'll give you a dollar to scratch my back. Or, cost can be actual and non-monetary, as with barter: You scratch my back and I'll scratch yours.

But if I'm lying on my back by the pool, checkin out the babes, I can't have my back scratched because I'm lying on my back.

That's not a cost. Not by any definition. Cost is what you have to give up to get the thing you want.

Cost is the value, usually the monetary value, of one side of a trade or exchange. In order to get my back scratched, I have to scratch yours. There is an exchange.

Or, I have to give you a dollar. There is an exchange.

I may have to give up lying on my back to get my back scratched, but this is not an exchange. It's just the way physical reality works. Besides, giving up lying on my back does not mean I will get it scratched. It only means that I can get it scratched because it's accessible. Physical reality. Nothing to do with exchange or trade. Nothing to do with cost.

I'm not giving up lying on my back in exchange for some scratching. Giving that up is not the exchange. It's not a cost. So it's not an opportunity cost.

The "Winter is coming" mindset

9 Dec 2018: Top IMF economist predicts 'sharper' US slowdown in 2020, France24.

10 Dec 2018: Morgan Stanley sees growing risk of 'earnings recession' next year as yield curve inverts, CNBC.

11 Dec 2018: IMF warns storm clouds are gathering for next financial crisis, The Guardian.

12 Dec 2018: Nearly half of corporate CFOs are expecting a US recession by the end of 2019, CNBC.

13 Dec 2018: Many U.S. Financial Officers Think a Recession Will Hit Next Year, WSJ.

13 Dec 2018: U.S. recession risks jump, Fed rate hike expectations slump - Reuters poll.

The accumulation of wealth gives rise to civilization

I left myself this note:

see
https://en.wikipedia.org/wiki/Civilization

and an excerpt from the file it links to:

All civilizations have depended on agriculture for subsistence, with the possible exception of some early civilizations in Peru which may have depended upon maritime resources. Grain farms can result in accumulated storage and a surplus of food, particularly when people use intensive agricultural techniques such as artificial fertilization, irrigation and crop rotation. It is possible but more difficult to accumulate horticultural production, and so civilizations based on horticultural gardening have been very rare. Grain surpluses have been especially important because grain can be stored for a long time. A surplus of food permits some people to do things besides produce food for a living: early civilizations included soldiers, artisans, priests and priestesses, and other people with specialized careers. A surplus of food results in a division of labour and a more diverse range of human activity, a defining trait of civilizations. However, in some places hunter-gatherers have had access to food surpluses, such as among some of the indigenous peoples of the Pacific Northwest and perhaps during the Mesolithic Natufian culture. It is possible that food surpluses and relatively large scale social organization and division of labour predates plant and animal domestication.

Civilizations have distinctly different settlement patterns from other societies. The word "civilization" is sometimes simply defined as "'living in cities'". Non-farmers tend to gather in cities to work and to trade.

Compared with other societies, civilizations have a more complex political structure, namely the state. State societies are more stratified than other societies; there is a greater difference among the social classes. The ruling class, normally concentrated in the cities, has control over much of the surplus and exercises its will through the actions of a government or bureaucracy. Morton Fried, a conflict theorist and Elman Service, an integration theorist, have classified human cultures based on political systems and social inequality.

I want to look at this, a fragment at a time.

"Grain farms can result in accumulated storage and a surplus of food" -- That's wealth. Grain farms can result in the accumulation of wealth, which is the basis of civilization.

"It is possible but more difficult to accumulate horticultural production, and so civilizations based on horticultural gardening have been very rare." -- Supporting the view that the accumulation of wealth is necessary for the rise of civilization.

"Grain surpluses have been especially important because grain can be stored for a long time." -- Grain surpluses, important not because we know everyone has enough to eat, but because we can add the surplus to our accumulation and be confident it won't go bad "for a long time". We're not treating grain as food here. We're treating it as wealth.

"A surplus of food permits some people to do things besides produce food for a living... A surplus of food results in a division of labour and a more diverse range of human activity, a defining trait of civilizations." -- Yes. And this defining trait of civilization arises because of the accumulation of wealth: The accumulation of wealth gives rise to civilization.

"However, in some places hunter-gatherers have had access to food surpluses, such as among some of the indigenous peoples of the Pacific Northwest and perhaps during the Mesolithic Natufian culture. It is possible that food surpluses and relatively large scale social organization and division of labour predates plant and animal domestication."

Okay, now I have to stop. They begin this thought with the word however which means they're about to disagree with the previous thoughts in the paragraph (and with my evaluation of them). Here:

"However, in some places hunter-gatherers have had access to food surpluses..."

It's easy to guess the unstated conclusion of that thought:

... but they were only hunter-gatherers, not a civilization.

This interpretation of their meaning is supported elsewhere in the article:

Morton Fried, a conflict theorist and Elman Service, an integration theorist, have classified human cultures based on political systems and social inequality. This system of classification contains four categories

• Hunter-gatherer bands, which are generally egalitarian.
• Horticultural/pastoral societies in which there are generally two inherited social classes; chief and commoner.
• Highly stratified structures, or chiefdoms, with several inherited social classes: king, noble, freemen, serf and slave.
• Civilizations, with complex social hierarchies and organized, institutional governments.

By this list, hunter-gatherers are the least complex category and civilizations the most complex category of human culture.

Okay. Perhaps we should say the accumulation of wealth is a necessary but not sufficient prerequisite for the rise of civilization. Perhaps; but we don't know that for sure. So let's just say the accumulation of wealth does not necessarily give rise to civilization.

But we don't know that, either. "All civilizations have depended on agriculture for subsistence," the article says. It may be that, given enough time, the accumulation of wealth does necessarily give rise to civilization. In any case there is a clear connection between civilization and accumulation of wealth.


Go back to what Wikipedia said about the hunter-gatherers: "in some places hunter-gatherers have had access to food surpluses". They give one example and one perhaps:

• some of the indigenous peoples of the Pacific Northwest
• and perhaps during the Mesolithic Natufian culture.

"It is possible," they conclude, that food surpluses (and relatively large scale social organization, and the division of labor) predate plant and animal domestication.

Okay. But a natural surplus of food -- good hunting and fishing, say -- is not the same as accumulation of wealth. The salmon that were "central" to the Indigenous peoples of the Pacific Northwest Coast were a "resource" provided by nature and owned by no one.

The natural surplus didn't exist because people had been accumulating it.

It's not that food was plentiful because the people were good gatherers. Rather the reverse: The people did well and their population grew because food was plentiful. "At one point the region had the highest population density of a region inhabited by Aboriginal peoples in Canada."

And they did develop "relatively large scale social organization and division of labour". Sounds like they were on their way to becoming a civilization.

I can see that a natural surplus of food could make civilization slow to develop. For the accumulation of wealth would have to depend on needs other than food. Newer, bigger, nicer homes, for example, or better tools to hunt and gather with.

The accumulation of wealth also depends on the concept of ownership. You know: This land is your land, this land is my land.

(with apologies to Woody Guthrie)

Development of the concept of ownership might be hindered by plentiful food. And if cultural development got the jump on wealth accumulation, and cultural growth outpaced the growth of wealth -- likely conditions, I should think, early on, among the indigenous peoples of the Pacific Northwest -- then the concept of ownership might even have been suppressed by a cultural imperative.

And as for the Natufians:

The culture was unusual in that it supported a sedentary or semi-sedentary population even before the introduction of agriculture. The Natufian communities may be the ancestors of the builders of the first Neolithic settlements of the region, which may have been the earliest in the world. Natufians founded Jericho which may be the oldest city in the world. Some evidence suggests deliberate cultivation of cereals...

Generally, though, Natufians exploited wild cereals.

Wild cereals. And they hunted gazelle. So again, nature provided. So there wasn't much need for farming. So there wasn't much of a chance for wealth to accumulate. And they didn't develop a civilization. Coincidence? Not likely.

More likely, the absence of civilization is evidence that they did indeed have natural food surpluses, not possibly, but definitely.

When did this happen?

Microfoundations: Fringe on a Rug

Here's a rug:

Raina Traditional Blue, from At Home

Here's economics:

The pattern in the center is macro.
The fringe at the edges, that's micro.

Here's Ray Dalio's picture of the economy:

See the fringe? The reasons we have, as buyers and sellers, for the choices we make.

The fringe is important. To us as buyers and sellers, and just as people, the reasons we do things are often extremely important to us. This is something behavioral economics wants to understand, the fringe, the reasons for our behavior, so that they can change our behavior. I don't like that. I don't like to be manipulated.

Sometimes, somebody's reasons are important to somebody else, as when one person tells a story about another person's reason for doing what they do, to make that person look bad. I don't like that, either. The reasons we have for doing the things we do, they're personal, and they're important. And you should never have to tell anybody what your reasons are. They're yours. Tell em to look at the results.

You should never listen to somebody talk about somebody else's motives. Nobody should ever make up stories about other people's motives, and as a general rule people should never try to change other people's behavior. Doing so is creepy at best. Except, you know, you have to listen to your wife.

Our reasons for the choices we make are personal and important -- to us. That's the fringe on the rug.

Once we make our choices and decide to act, what happens in the economy is described by the middle part of Dalio's picture: The arrows pointing toward the center, and the relation between "Total $" and "Total Q". This is where transactions occur. This is where the economy exists.

This is where macro exists.

Nothing could be more irrelevant to macro, than micro. Nothing could be less relevant. You can even see it in a rug.

Imagined horrors: Additional notes on the Friedman interview

In a footnote in Breit and Ransom's The Academic Scribblers at Google Books, the authors quote from the “Has the New Economics Failed?” interview with Milton Friedman, and write:

In this interview, Friedman repeated one of his favorite propositions, "The best is often the enemy of the good," to point out that the use of both monetary and fiscal policy according to the well-intentioned precepts of functional finance has made the economy more erratic rather than smoother.

It's not simply fiscal policy Friedman is criticizing. He has a problem with any policy -- fiscal or monetary -- that attempts to "fine tune" the economy. In the interview he said

I’m not in favor of fine-tuning in that sense. I don’t believe we know enough to be able to do it. I don’t object to the aim; it would be very desirable to have an instrument that would enable us to keep the economy on an even keel. But I don’t think there is any. We do not know enough about either fiscal or monetary policy to enable us to make delicate adjustments from time to time that are going to offset other forces and make for greater stability in the economy.

Powerful stuff. With the interviewer's next question, focus returns to fiscal fine tuning: the tax cut of 1964. Friedman describes the performance of the economy before the tax cut became law:

There was a slowing off in the economy in late 1962 and early 1963, and there was a picking up of steam in the economy in late 1963 and early 1964— all of which happened prior to the tax cut.

"That steam kept on picking up at the same rate after the tax cut," he adds. This is where he says

some people will say that the economy moved ahead in late 1963 in anticipation of the tax cut. But then they also say that the actual occurrence of the tax cut fostered the growth afterwards.

And he dismisses that view as double-counting.

But then Friedman says:

If you want to explain the behavior of the economy during those periods, there is a much simpler explanation. In the middle of 1962 there was a sharp tapering off in monetary growth; some time in early 1963 there was a sharp speeding up of monetary growth. About six months after each of these, the economy showed the same movements. In a nutshell, the characteristic feature of this whole period, except for the 1962 interruption, was a steady rate of growth in the quantity of money.

In other words, the appropriate method of fine-tuning the economy is to keep "a steady rate of growth in the quantity of money."

So much for not knowing enough to make the delicate adjustments that offset other forces and increase the stability of the economy.


Premise: The use of fiscal policy (like the 1964 tax cut) to smooth the economy's performance is an unacceptable delicate adjustment.

I have to ask: How is it not also an unacceptable delicate adjustment to use monetary policy to smooth the economy's performance by maintaining a steady rate of growth in the quantity of money?

Observation: Friedman says neither fiscal nor monetary policy should engage in fine tuning, but he doesn't really mean it. He wants to fine-tune the growth of money so it is steady.

He doesn't want to turn tax policy "on and off like a faucet." But he definitely wants to step on the gas -- or the brake -- if money growth deviates from a straight and narrow path.


Two questions later the interviewer asks: "You would rely, then, entirely on monetary policy?" Friedman responds:

It depends on what you wish to rely on it for. I would not use monetary policy as it was used in the 1920s in any futile effort to fine-tune the economy. I bring out this comparison because at that time they were trying to do with monetary policy exactly what the New Economists are now trying to do with fiscal policy. To say that it didn’t work is to understate the case.

By understating the case Friedman appears to mean forgetting to mention that monetary policy in the 1920s created the Great Depression. But Friedman understates his case.

The best zingers are understated, no?

What really bothers me here is that Friedman says in the 1920s "they were trying to do with monetary policy exactly what the New Economists are now trying to do with fiscal policy." But he's offers no specifics. Friedman reminds us that the monetary policy of the 1920s created an economic disaster, then says fiscal policy of the 1960s is doing "exactly" the same.

It's innuendo. Friedman is not specific. We are left to fill in the blanks for ourselves, like a Hitchcock movie. And the human mind is very good at filling-in those blanks with imagined horrors.

Me, I don't know much about what else Friedman might have meant. So I turned to The Federal Reserve in the 1920s at New World Economics, which shows this graph:

Graph #1

And from that same page:

... by the early 1920s, the Fed had already gotten into the habit of being involved in the lending market on a day-to-day basis. During WWI, the Fed had been pressured by the Treasury to keep a lid on short-term and long-term interest rates to allow the Federal government to more easily finance its big wartime deficits. This of course required daily action. The Treasury stopped telling the Fed what to do after the war, but by then the Fed had become accustomed to being regularly involved. Bureaucratic expansion itself would have prevented any migration to the kind of largely dormant institution as the Fed was originally envisioned.

That's the context. Here's the policy the Fed pursued:

The Fed’s discount rate was kept at a level that made the Fed competitive with other potential lenders in the market. This was actually quite similar to the regular operating conditions of the Bank of England at the time. The Bank of England was also a private profit-making commercial bank, and thus made loans regularly. The Bank of England was not at all a dormant institution that only leapt into action during a once-a-decade crises. The Bank of England thus also had to keep its discount rate in line with other banks’ lending rates to stay competitive. In practice, the amount of actual loans made by the Fed or Bank of England was somewhat up to the discretion of the bank managers. If their rates were competitive and there was regular demand for borrowing, the Fed or the BoE could decide how much it actually wanted to lend.

In those early days, the Fed relied on the discount rate rather than the federal funds rate. They kept the discount rate "competitive": They let it vary with the rates of "other potential lenders". From the graph, this evaluation of early Fed policy appears correct.

So the Fed kept the discount rate competitive, and Friedman calls this a "futile effort to fine-tune the economy."


I could easily be wrong, and Friedman right. I know he studied this a lot more than I have. But here's the thing: He's only stating overviews. He provides no evidence. No examples. Nothing to let me understand why he says what he says. And when I go looking to see for myself, I don't see what I would see if Friedman was right.


After Friedman's understated zinger about understating the case, the next interview question is this:

You would merely expand the money supply by a certain rate and not concern yourself about the discount rate, open market operations or the other monetary powers of the Federal Reserve?

Friedman's response:

Not exactly. While I am opposed to using these weapons to fine-tune, under our present financial institutions having the quantity of money increase at a steady rate requires a great deal of intervention and action by the Federal Reserve. As it happens, I’m in favor of much more fundamental changes in our financial institutions. But under our present institutions, we can only get a steady rate of increase in the money supply if the Federal Reserve takes that as its objective and works on it. At certain times it would have to buy government bonds on the open market, at other times it would have to sell. It would also have to keep its discount rate in line with market rates, and so on.

I think that a misleading impression is given unless I add one thing: I’m in favor of a stable fiscal policy too. My view is that the problem with our fiscal and monetary policies is that the objective has been to offset other forces and thus insure stability. The actual result has been to introduce new instabilities. There’s the old saying—I’ve forgotten to whom it is attributed—that the best is often the enemy of the good. That is the case here. The attempt to use both monetary and fiscal policy for delicate adjustments in the economy has made the economy more erratic rather than smoother.

Again: Friedman objects to the idea of trying to "offset other forces and thus insure stability" because the "attempt to use both monetary and fiscal policy for delicate adjustments in the economy has made the economy more erratic rather than smoother."

He's comfortable with the idea that if you do nothing you don't introduce instability. And yet, he doesn't want to see money growth slow down as it did in the middle of 1962. He wants to prevent the erratic growth of money.

The other guys talk of fine-tuning the growth of the economy; Friedman's idea is to fine-tune the growth of money. But he pretends the other guys are fine tuning and he is not.

Friedman is interfering, the same as the other guys. But he pretends he is not.


Let's go back to that "stability" thing:

• The zinger is about policy creating the Great Depression. That's not stability.
• The whole interview is about policy trying to attain "greater stability in the economy."

It seems that by "stability" we mean minimizing recessions and eliminating depressions.

Here's a picture showing the duration and frequency of recessions since 1854:

Graph #2

The left half of the picture is mostly gray; the right half is mostly white.

The left half is mostly recession; the right half is mostly growth.

The dividing line appears to occur at the end of the Great Depression (March 1933). If recession is the measure of economic instability, our economy has been noticeably more stable since the end of the Great Depression.


I'll re-quote from "The Kennedy Tax Cut of 1964":

The economists in the Kennedy administration observed that there had been three recessions in the two Eisenhower administrations (1952–1960): one from 1953 to 1954 after the Korean War, one from 1957 to 1958, and one in 1960.

And from Time magazine of December 31, 1965:

They began to use Keynes's theories as a basis not only for correcting the 1960 recession, which prematurely arrived only two years after the 1957-58 recession, but also to spur an expanding economy to still faster growth.

There were three recessions in Eisenhower's eight years, the last of them in 1960 as Kennedy came into office. These recessions were fresh in the minds of Kennedy's Council of Economic Advisors, and they set to work shortening that 1960 recession.

And there wasn't another recession until 1969. A long stretch. You can see it on Graph #2: the three close recessions of the Eisenhower years, followed by a clear span till 1969. So it looks like the "fine tuning" of the 1960s had the desired effect. (Along with some side effects, perhaps, like rising inflation.) But if the measure of economic instability is recession, then there is evidence that economic stability has increased.


And after ruminatin, I can't really see that Friedman "has a problem with any policy -- fiscal or monetary -- that attempts to 'fine tune' the economy." I can see that he says he has a problem with it. But I don't see it in the other things he says.

RE: Milton Friedman's 1968 critique of "the new economics"

Excerpts from and commentary on “Has the New Economics Failed? An Interview with Milton Friedman.” (PDF, 9 pages)

The second question:

Q: Assuming that the New Economics is nothing very new, how would you evaluate its accomplishments between 1961 and today?

A: It is very hard to say that the New Economics has accomplished very much of anything, except getting a great deal of publicity. I have always been amused by the fact that the New Economists emphasize fine-tuning—or changing the direction of the economy within a short span of time. But if you look at what actually happened, it certainly did not occur over a short span of time...

My first hint that by fine-tuning we mean "changing the direction of the economy within a short span of time" occurs in the middle of a sentence about something else. It is a definition-by-accident, in a way. Does it make sense? On my first read I said Yeah, okay. I accepted Friedman's reduction of the meaning of the term "fine tuning" to "in a short span of time".

But it's ridiculous. Nothing in the economy happens "in a short span of time". Friedman uses a kind of straw man here, a definition that can easily be shot down -- if you haven't already accepted it. It is not really a definition of the term, at all.

Worse, he introduces this definition mid-sentence, as if by accident. (Oops, did I forget to define the term?) The reader is trying to understand what Friedman is saying, and is therefore led to accept Friedman's definition rather than to evaluate it. If Friedman had defined the term separately first, we would have been led to evaluate his definition, and accept it or not.

The language Friedman uses, burying the definition mid-sentence, suggests that he does not want us to spend much time evaluating the definition.


The third question:

Q: To get around such delays, would you then favor giving the President the right to raise and lower taxes within a narrow limit subject to a Congressional veto?

A: No, I am opposed to it, because I’m not in favor of fine-tuning in that sense. I don’t believe we know enough to be able to do it. I don’t object to the aim; it would be very desirable to have an instrument that would enable us to keep the economy on an even keel. But I don’t think there is any. We do not know enough about either fiscal or monetary policy to enable us to make delicate adjustments from time to time that are going to offset other forces and make for greater stability in the economy.

This question immediately follows Friedman's answer in which he offers his accidental definition of "fine tuning". Notice that the interviewer accepts Friedman's definition and builds on it by asking about getting around such delays. The interviewer doesn't pause and wonder Is this a good definition? He runs with it.

I can only imagine that Friedman was hoping for similar acceptance of the definition from his readers: acceptance without evaluation.

By contrast, Investopedia's definition of fine tuning has nothing to do with delays or short spans of time:

Fine tuning refers to the process of making small modifications to improve or optimize an outcome. Generally, fine tuning seeks to increase the effectiveness or efficiency of a process or function. Fine tuning can be accomplished through a variety of ways, the methodology of which depends on the process being optimized.

Surely, Milton Friedman would not say he is opposed to "making small modifications to improve or optimize an outcome". Or maybe he would, I don't know. But it must be easier for people to accept a sweeping rejection of delay than a sweeping rejection of improvement. Friedman's definition of "fine tuning" makes his argument against the new economics easier to accept.

It makes the argument easier to accept.

Presenting the definition as if by accident makes the definition easier to accept. And then, accepting the definition makes Friedman's argument easier to accept. But it's all bullshit.

More accurately, it may all be bullshit; it depends upon our evaluation of his accidental definition of "fine tuning".

//

But this is good:

We do not know enough about either fiscal or monetary policy to enable us to make delicate adjustments from time to time that are going to offset other forces and make for greater stability in the economy.

That's a beautiful statement. An admission that economists don't know enough to be able to optimize economic outcomes. You don't see an admission like that very often. Not very often.


Question 4:

Q: What about rough adjustments? While that famous tax cut was very late, it did seem to work.

A: Did it? What effect did it have? Lets go back and look at the record. There was a slowing off in the economy in late 1962 and early 1963, and there was a picking up of steam in the economy in late 1963 and early 1964— all of which happened prior to the tax cut. That steam kept on picking up at the same rate after the tax cut. Now some people will say that the economy moved ahead in late 1963 in anticipation of the tax cut. But then they also say that the actual occurrence of the tax cut fostered the growth afterwards. You can’t count it twice; you can’t have it over and over again.

"You can’t count it twice", Friedman says.

What?? There is no "twice". The economy started picking up steam in late '63, and continued picking up "at the same rate" (Friedman says) after the 1964 tax cut. From this, Friedman concludes that people double-count the effect of the tax cut when they say both that

• the economy moved ahead in late 1963 in anticipation of the tax cut, and that
• the actual occurrence of the tax cut fostered the growth afterwards.

Double-counting? Really? No, not really. We get a boost before the fact, from expectations. And then we get a boost after the fact, if the expectations pan out.

Friedman's "You can’t count it twice" argument looks like serious bullshit to me.

//

As Friedman describes it, "late 1963 and early 1964" was "prior to the tax cut." Going along with the semiannual rhythm Friedman uses, I assumed from his remarks that the tax cut came in "late" 1964 (and I wrote it that way). In proofread I checked this, and of course it was wrong. I found “The Kennedy Tax Cut of 1964”, section 27.2 from the book Theory and Applications of Economics, which says

As is usually the case when a major fiscal policy action is under consideration, there was a lengthy time lag between the initiation of the policy and its implementation. Even though the tax cut was proposed in 1962, President Kennedy never saw it put into effect. He was assassinated in November 1963; the tax cut for individual households and corporations was not enacted until early 1964.

Early 1964. Wikipedia confirms:

The United States Revenue Act of 1964 (Pub.L. 88–272), also known as the Tax Reduction Act, was a bipartisan tax cut bill signed by President Lyndon Johnson on February 26, 1964.

February 26. Early 1964. Maybe the tax changes of early 1964 didn't have an effect until later; maybe that's what Friedman meant. That's fine. After the changes took effect (whenever that was), you've got growth from the tax cut (according to Friedman) and before the changes took effect you've got growth from "expectations" of the tax cut. It's not double-counting to count both effects, if both occurred.

To call it double-counting and dismiss it, is bullshit.


Two paragraphs from that "Kennedy Tax Cut of 1964" chapter give a good feel for what was going on in those years:

Every president has a group of economists, known as the Council of Economic Advisors (CEA; http://www.whitehouse.gov/cea), that provides advice on economics and economic policy. The list of members and staff of the 1961 CEA reads today like a “who’s who” of economics. James Tobin and Robert Solow were prominent members of the economics team; both went on to win Nobel Prizes in Economics. The chairman of the CEA was Walter Heller, an economist known for a wide variety of contributions on the conduct of macroeconomic policy.

The economists in the Kennedy administration observed that there had been three recessions in the two Eisenhower administrations (1952–1960): one from 1953 to 1954 after the Korean War, one from 1957 to 1958, and one in 1960. You can see these in Figure 27.4 "Real GDP in the 1950s". The CEA members and staff thought that more aggressive fiscal and monetary policies could be used to keep the economy more stable and prevent such recessions. Their goal of moderating fluctuations in the economy was based on the framework of the basic aggregate expenditure model, which had been developed in the aftermath of the Great Depression, augmented by some developments in economic thinking from the 1940s and 1950s. Based on that analysis, they believed that fiscal and monetary policies could be used to control aggregate spending and hence real GDP.

That's what they were doing with "the new economics" of the 1960s. It doesn't sound to me at all like their focus was as Friedman describes: "changing the direction of the economy within a short span of time". Not at all.

Here's how Time magazine described the goals of the new economics in a 1965 article:

In Washington the men who formulate the nation's economic policies have used Keynesian principles not only to avoid the violent cycles of prewar days but to produce a phenomenal economic growth and to achieve remarkably stable prices. In 1965 they skillfully applied Keynes's ideas—together with a number of their own invention—to lift the nation through the fifth, and best, consecutive year of the most sizable, prolonged and widely distributed prosperity in history.
...
In the early 1930s, Keynes cried out that the only way to revive aggregate demand was for the government to cut taxes, reduce interest rates, spend heavily—and deficits be damned.
...
Keynesianism made its biggest breakthrough under John Kennedy, who, as Arthur Schlesinger reports in A Thousand Days, "was unquestionably the first Keynesian President." Kennedy's economists, led by Chief Economic Adviser Walter Heller, presided over the birth of the New Economics as a practical policy and set out to add a new dimension to Keynesianism. They began to use Keynes's theories as a basis not only for correcting the 1960 recession, which prematurely arrived only two years after the 1957-58 recession, but also to spur an expanding economy to still faster growth.

It surely does not sound like the focus of "the new economics" was to change the direction of the economy in a short span of time. Change the direction? Yes. They wanted to improve things. But Friedman does not focus on their efforts to improve things. He focuses on the "short span of time" and suggests that the New Economics was a failure because they couldn't get things done quickly.

Friedman's focus is flawed.

"The new economics"

My sister was in third grade, puts us in 1960 give or take, when she came home from school one day talking about "the new math". These days, oddly, it is still called the new math. So it goes.

I'm not here now to talk about math. I'm here to talk about economics. Specifically, "the new economics". Oddly, this too arose some time around 1960.

The phrase "the new economics" reminds me of Time magazine's December 31, 1965 article on Keynes and the Keynesians of the '60s. Find the article at Brad Delong's.

Meanwhile, I'm at the Collected Works of Milton Friedman page at the Hoover Institution, looking for other things. I searched the page for interview, financial times and one of the first results that came up (of 840) was

Has the New Economics Failed? An Interview with Milton Friedman (February 1968).

The new economics? From 1968? I had to go there. This has to be related to the Time article: Friedman's response to a Keynesian challenge.

Click the picture of the article to get a 9-page PDF: Interview. “Has the New Economics Failed? An Interview with Milton Friedman.”* Interviewed by Gerald R. Rosen. Dun’s Review, February 1968, pp. 38-39, 93-94, 96.

I can't wait to read this one!

Interesting note on Milton Friedman

According to William Keegan of The Guardian, Milton Friedman

distanced himself from Thatcher's belief that public sector borrowing should be reduced in times of recession.

That's not a small thing.

Growth and Civilization

Ref: Economics Prof Tyler Cowen says our overwhelming priorities should be maximising economic growth and making civilization more stable. Is he right? An interview with Cowen, by Robert Wiblin and Keiran Harris.

On Getting Growth

Robert Wiblin: All right, let’s move on to the book, Stubborn Attachments... How would you summarize the key messages of this book? And how did you come to write it?

Tyler Cowen: The underlying message of the book is simply, we’re capable of making rational judgments about what is better for society. In my own discipline, economics, there’s a long-standing thread of skepticism about that. Kenneth Arrow developed an impossibility theorem. There are a lot of results that imply you can’t say much about what’s actually better.

I agree with Cowen that economic growth is good. But his "underlying message" makes me nervous. He seems to think that all we have to do is is sit down and be rational, and all will be well. I think the economy is a system, and our task is to understand how the system works. And I think Cowen's underlying message is an example of not doing that.

I think you have to look back in time to when the problem started, and see where it started and what happened. Then you have some clues about what the problem really is and how to solve it. The necessary first step is to understand the problem. We skipped that part. We assume that we understand the problem.

So you've got a bunch of guys who think "you can’t say much about what’s actually better". And you've got Tyler Cowen who throws out that baby with its bath water, stomps his foot on the floor, and says Yes you can! And here I am, saying stop all this nonsense, swallow your pride, and figure out what the damn problem is.

"Exponential compounding growth"

Robert Wiblin: Let’s talk about a couple of the key ideas. One is the Crusonia plant and compounding growth. What would you talk about there in the book?

Tyler Cowen: The Crusonia plant is a somewhat obscure reference. It’s taken from the works of Frank Knight, University of Chicago economist. Knight postulated there was such a thing as a Crusonia plant. It was a hypothetical. It would simply keep on growing forever, so it would be of very high value. It’s like an apple tree. Seeds fall. You get more apples. Those seeds, in turn, get you more apple trees, and so on and so on.

That’s exponential compounding growth. So if you don’t discount the future at a very high rate, if you had such a thing as a Crusonia plant, it would be very valuable.

A ridiculous comparison! Compounding is like apples. It's more like weeds that keep on growing and spreading and taking over your yard... and have a very low value.

Tyler Cowen: Then if you ask, “What, in fact, is a Crusonia plant?” It’s a modern, well-functioning economy that does generate more output every period at something like an exponential rate of growth, and it’s highly valuable. So we want to cultivate, again, economic growth.

Robert Wiblin: Why do you think the economy grows in this way where shocks or improvements seem to be permanent or at least semipermanent?

Tyler Cowen: People generate new ideas, and most new ideas don’t disappear. You can lose a new idea or have a Dark Ages. But if you have good institutions, you build upon those new ideas.

Cowen makes it sound simple: If you want good growth, you just need good institutions, which build on good ideas. Presto! No more Dark Ages.

Cowen drives me to Arnold J Toynbee, who writes:

When a civilization is in decline it sometimes happens that a particular technique, that has been both feasible and profitable during the growth-stage, now begins to encounter social obstacles and to yield diminishing economic returns; if it becomes patently unremunerative it may be deliberately abandoned.

When a civilization is in decline things go downhill. Cowen is saying all we have to do is push them back up the hill and all will be well.

I say you have to figure out the reason things are going downhill. I say that if you're not solving the right problem, your solution won't solve the problem. And it may end up making things worse. This is the story of the last 50 years.

Toynbee continues:

... if it becomes patently unremunerative it may be deliberately abandoned. In such a case it would obviously be a complete inversion of the true order of cause and effect to suggest that the abandonment of the technique in such circumstances was due to a technical inability to practise it and that this technical inability was a cause of the breakdown of the civilization.

It is not that a loss of skills (or institutions) leads to abandonment of technology (or ethics and morals) and causes the decline of civilization. Rather the opposite: the decline of civilization is part of a business cycle that can endure for millennia; during the decline, some technologies (ethics, morals) become unprofitable and are therefore abandoned; the loss of skills (and institutions) follows.

Cowen says all we have to do is push our skills and our institutions back up the hill and presto our problems are solved. That's wishful thinkin.

There's a lower bound on interest rates, but not on "dumbing it down"

Noah Smith, Why a Great U.S. Economy Doesn’t Feel So Great, at Bloomberg:

Various subfields of economics deal with the gritty details of things that are thought to affect productivity — taxes, public goods, economic development, education, health, research and development, financial markets, etc. Increasingly, these fields — which comprise a majority of what economists study — are grouped together under the name of microeconomics.

In the short term, economists believe, the business cycle can cause fluctuations around the long-term trend. When a financial crisis, tight monetary policy or some other shock causes aggregate demand for goods and services to fall, businesses stop investing and lay off workers. The ensuing recession causes a mismatch — offices and factories sit empty, while workers who could fill those offices and factories stay at home playing video games. The downturn doesn’t last forever, but in the most severe situations it can persist for as long as a decade. The branch of economics which deals with this sort of temporary phenomenon is called macroeconomics.

So "the gritty details of things that are thought to affect productivity", that's micro. Macro, meanwhile, is short-term mismatches and temporary phenomena.

Keynes rolls in the grave.

Me, I'm frozen in disbelief.

A fault line in the banana

FRED Blog asks: Are we moving toward a cashless economy? They ask an interesting question. And they answer it, it seems to me, with a rather definite "No".

However, their conclusion is "the question remains open."

I'm confused by their post, so I'll leave it alone. But the graph they show is for currency in circulation. I've got monetarist blood, so I looked at it. Then I looked at currency in circulation relative to GDP, because, you know, context.

It's a banana, currency relative to GDP, low in the middle and high on the ends. The graph reminds me of a Scott Sumner post from two or three years back. Sumner said Currency-to-GDP is the inverse of velocity. He said interest rates move with velocity. And yeah, I'm leaving that alone too.

Here is the banana:

Graph #1: Currency in Circulation relative to GDP

I'm lookin at currency in circulation relative to GDP, and I see something no one else seems to notice. Or maybe it's that no one else thinks it is worth bothering with. But it sure looks important to me: Between the years 2000 and 2010, there is an interruption in the banana.

I brought the data into Excel and put a trend line on it. Two trend lines, actually: second order polynomials, both of them.

Graph #2

The blue line shows currency in circulation relative to GDP, just like on the first graph. The red is identical, and hides most of the blue. But there are two red segments here, each indicating the data used to generate one of the trend lines.

The long red (1951Q1-2003Q2) creates the basic banana shape that is so obvious on the graph. Then, after the interruption (2003Q2-2008Q2), the banana-path resumes, as shown by the short red (2008Q2-2018Q3).

But there is a problem with this simplification. Short red is low: lower than the trend of the long red banana. It also appears that short red is curving the wrong way; but I will say no to this, because short red is going the right way to become a flatline. I like flatline ratios: they suggest the approach of economic stability. Just one problem, then: Short red is low.

One could argue that the short red, running low, is a cause or a consequence, or both, of the economic sluggishness of the past decade. I would make that argument: Slow economic growth and slow growth of the quantity of money go hand in hand. Definitely.


Here is a detail of the "fault line" in the banana:

Graph #3: Currency Trends Detail

The fault line is blue. Notice that it starts in 2003 and ends in 2008. This fault line is not the result of the Global Financial Crisis or the Great Recession. The fault line came before those events and, if anything, was the cause of them.

"2 years of 10% and 0% growth is not the same as 2 years of 5% growth."

In comments here the other day, Jim said:

Its not very meaningful to average percentages. 2 years of 10% and 0% growth is not the same as 2 years of 5% growth.

Jim said pretty much the same thing a few years back. I can't find that older remark, but it definitely got stuck between my ears. Since it came up again now, I thought this time I'd actually take a look at some numbers. Because without looking at the numbers I can't make progress, and it'll be a loose end in my head forever.

So I opened up Excel and typed 5% Every Year. And then I typed 10%, 0%, 10%, ...

And I looked at what I had, and those were the two conditions Jim specified: one of constant and one of alternating growth. I thought about it. And then I added another one: Random growth one year, and then enough growth the next year to bring the two-year total to 10%. (The third year again random, and the next bringing the two-year total to 10%; etc.)

I generated numbers enough to fill the cells below the three labels, but not more than I could see on the screen. But this seemed unsatisfactory because it only amounted to about 30 years of growth. I should figure more than 30 years, I thought. So I added some more, and the screen scrolled, and when I got 40 years of growth I figured that was plenty.

(These decisions I make, based on impressions and impulses and a desire to keep most of my data visible on the screen... is this how science is done?)

I was going to number the first row of data "Year 0". My starting point. That way the second row, the first year of growth, would get a "1" in the Year column. But then, no. Because I knew I'd be looking at exponential trend line equations to see the growth rates for my different columns of data. And exponential trend lines want my "Year" numbers to start with 1. Not zero.

So I made my first year Year 1 even though it's just a starting point and not a measure of change. That made the first change appear in Year 2. And that made the 40th change appear in Year 41. I hate this one-year discrepancy, because if I don't explain it it looks like a mistake. And if I do explain it, it looks like I'm making excuses. But it's just the way Excel works. Either that, or Excel and I have a serious misunderstanding.

Here is the graph I came up with:

Graph #1: A Comparison of Constant and Averaged Growth Rates

I put trend lines and trend line equations on the graph, then hid the trend lines because I just need the equations. The trend line equations on the graph are color-coded to match the lines and the legend. Blue shows 5% growth every year. The trend line equation shows a 4.88% growth rate; this differs from 5% because of compounding, I suppose. Nothing is easy.

Red shows alternating growth: 10% one year, 0% the next, and repeating. This gives an average growth rate of 5% but of course the red line is not a smooth curve. It is up-and-down, up-and-down, like a saw-tooth. The trend line equation shows an exponential growth rate of 4.77%.

That's close to 4.88%, I told myself.

Green uses a random number between 0 and 10 as the growth rate for one year, and then 10 minus that growth rate as the rate for the next year. Then for the following year a new random number; and for the year after that, again the difference from 10. This gives a series of two-year averages each equal to 5%; the trend line equation shows 4.88%, just the same as the blue line.

Now I'm going to ignore the green and concentrate on the red.


The red exponential rate is a little low. And at the right side of the graph, you can see that my red line ends at a low point of the sawtooth. I thought these two lows might be related. So I added one more year to the graph, to make that red line end at a high point of the sawtooth. You can see the red line scoot up at the end:

Graph #2: Like Graph #1 but with One Additional Year

However, there is no change in the 4.77% exponential trend rate. I should have known.

Looking at that red line now, it appears that for the first half of the graph, the high points of the sawtooth are noticeably above the blue line. But in the latter half, the lows of the sawtooth being below the blue is what stands out. This seems to be telling me that the red line is not growing as fast as the blue line.

4.77% versus 4.88% growth: I should have known.

Okay. So I figured, let's look at the difference between red and blue. The one minus the other. Get rid of the exponential upward sweep, and consider the red line relative to the blue.

Also, the difference between green and blue.

Graph #3: Differences from the Constant Rate of the Blue Line

Okay: The red line is definitely not keeping up with the blue.

The green line is easily explained with one word: "random". But the red one, the red one is interesting. At the start, red is almost entirely above the zero line: Red is greater than blue. By the end, red is almost entirely below the zero line: Red is less than blue.

If the graph kept going for another 40 years, I expect we'd see the red continue downward.

Notice also that the zigs and zags of the red grow longer as we go from left to right. The difference between red and blue is getting bigger. But don't forget, the red and blue on Graph 1 and 2 also get bigger as we go from left to right. So the question now is: Is the difference increasing faster than the blue line, or slower, or is it keeping pace? And that's our next graph:

Graph #4: Differences as a Percent of the Blue Line

Now the red zigs and zags are all of equal length, or nearly equal anyway. So I want to say the red difference is keeping pace with blue. And yet, for the years shown, the red difference starts out on average at around 2% of the value of blue on the high side; and 35 or 40 years later we find it on average again around 2% the value of blue, but on the low side.

I have no doubt that if we continued the graph out for another 40 years or so we would see the red zig-zag continue on its downward path. Actually, what's happening here reminds me of Bruce Boghosian's The Growth of Oligarchy in a Yard-Sale Model of Asset Exchange (PDF, 15 pages). See The Mathematics of Inequality at TuftsNow:

This is essentially a coin toss, and you might think that in the end both sides would end up with the same amount of wealth. But it turns out those who have more keep getting more.

Yeah, I thought "both sides would end up with the same amount of wealth". Or in this case, with the same amount of growth. Now I'm seeing this is not the case.

In Fair coin, foul outcome I looked at some Excel graphs of the process Boghosian describes. My last graph there shows the same zig-zag pattern of decline that turned up in Graph #4 above. And I figured out how the process works:

Consider a two-transaction sequence. On average in a two-transaction sequence, because the coin is fair, the rich guy and the poor guy should each win one of the wealth transfers. There are two ways this can happen:

1. The rich guy wins the first transfer, and the poor guy wins the second. Or
2. The poor guy wins the first transfer, and the rich guy wins the second.

If the rich guy wins first, the first transfer reduces the poor guy's wealth. So the second wealth transfer is smaller. The poor guy loses the larger transfer and wins the smaller one. Therefore, his wealth is reduced.

If the poor guy wins first, the first wealth transfer increases the poor guy's wealth. So the second wealth transfer is larger than the first. The poor guy loses this larger transfer. Therefore, his wealth is reduced.

Either way, the poor guy loses.

I had in mind to say this of the red pattern on Graph #4: Jim is right. Two years of 10% and 0% growth is not the same as two years of 5% growth. And, all else equal, it looks like low volatility of economic growth will over the long term produce greater growth than high volatility. However, the economy never grows in a persistent alternating pattern like the "10%, 0%, 10%..." example. Not over the long term.

And I was going to say: "So Jim is right, but the effect on the economy must be of little consequence." I was going to say that, but now, no. And now also I must omit the "However, the economy never grows in a persistent alternating pattern" and the rest of that paragraph.

Beyond that, I have to think about this some more.

The story is satisfying, but the argument is not

I remember now. I was fascinated by Jacob Assa's "Final GDP" story once before, back in March of this year. Then I started looking into the numbers and was disappointed. I began by showing one of Assa's graphs:

Graph #1: Jacob Assa's Figure 2, US GDP (constant prices) and total employment, 1977=100

Assa offers the gap between employment and output as evidence that Real GDP overstates output by figuring finance as productive activity.

The graph shows Real GDP and employment running together until the early 1980s, when GDP accelerates and employment starts falling behind. Fascinated, I went to FRED to see if I could duplicate the graph using GDPC1 and PAYEMS.

Yes, I could duplicate the graph. Using data since 1977, indexed to 1977, the lines on my graph followed a pattern similar to Assa's. I even got similar index values for 2011 where his graph ends: 260 for GDP (versus Assa's 250) and about 160 for employment (versus 150).

Of course, when I created my duplicate graph at FRED, it didn't start with 1977. It showed all the data, as FRED does by default, going back to the late 1940s for Real GDP, and even earlier for employment. And when I looked at all the data, I didn't see GDP and employment "running together until the early 1980s". I saw them running together only for about ten years, beginning in the early 1970s.

Graph #2: Real GDP (blue) and Total Employment (red)

This graph shows GDP rising more rapidly than employment in recent decades, when the difference can be attributed to what Assa calls "the financialization of GDP". But it also shows GDP rising more rapidly than employment from the late 1940s to the early 1970s, when it should not. And there is a decade, beginning in the 1970s, where GDP and employment run together, when they should not:

"Under SNA 1953 the financial sector would have thus shown a negative £6.1 billion value added. “Adopting SNA 1968 had, in effect, made UK finance productive” (Christophers 130, emphasis in original)."

Real GDP and employment do not run together in the early years, though it seems to me that by Assa's argument they should. And then they do run together for a decade mid-graph, after 1968, when by Assa's argument they should not. Assa's graph does not show the early years' mismatch, a mismatch that does not support the "financialization of GDP" argument. And then the graph shows about half of the "running together" decade in the middle, enough that we may imagine GDP and employment were running together from the start, as his argument implies. Thus, what remains is a graph which appears to support Assa's argument.

I felt deceived.


In a comment on mine of last March, Jerry reminded me that

it makes sense that RGDP should go up faster than the size of the workforce, even if there is no funny business involved with how finance is tracked -- from technology.

Good point, but I still felt that Assa's argument was not really supported by the data. The only other option I can see is that I'm misinterpreting the argument. Maybe a year from now I'll read his stuff again...

Evaluating my graph showing all the data, Jerry added

Exponential graphs are hard to look at on a linear scale like this -- the right side always looks bigger than the left side, even if it's not really.

Jerry thought it might be better to compare the growth rates of real GDP and employment. He presented a graph and said

It does look by eyeball there like there is a pre/post 1980 change. The blue is always above the red from 1980 to 2008.

Yeah. But I think the change that strikes Jerry's eyeball there is called "the Great Moderation".

So I looked at the growth rates. Here's what I got:

Graph #3: The difference between the RGDP Growth Rate and the Employment Growth Rate

At FRED they still haven't fixed the major glitch that incorrectly saves your graph settings when you click the Page short URL option. That's okay: I was ready for em this time. I got a screen grab of the graph settings, just in case.



That's about as far as I got, back in March, with my disappointment in Jacob Assa's argument. This time I want to stay on the case a little longer.

I downloaded the growth-rate-difference data to Excel and recreated the graph there. Looking at it, it seemed to me that the spikey data ended (and the "great moderation" began) with the data point at Q2 1984. So I figured two averages: one ending and another one starting at that date. This way I could compare the average performance of the period when the data seems to show the increasing financialization of GDP, to the period when it doesn't.

Graph #4: Same as #3, with Averages before and after Q2 1984
You can click the graph to see it bigger.

The average per-quarter growth rate difference for Q4 1947 thru Q2 1984 is 0.37551 percent. The average per-quarter value for Q2 1984 thru Q3 2018 is 0.32239 percent. The difference of the averages is 0.05311 percent. Multiply by 4 to approximate annual growth rates, and I get 0.2%. (To five decimal places,  0.21245%). The difference is about one-fifth of one percent less in the late period.

The difference is less, in the late period. What does that mean? It means employment growth and RGDP growth are more similar in the late period than in the early period. It means I'm not finding the financialization of GDP that explains things for Jacob Assa. I'm not finding it.



I guess I could have done it differently. I could have looked at the original source data (my graph #2 above), picked data points for the time that the two data sets are running together, and excluded that period from my calculation. Compare the before to the after, in other words, leaving out the middle.

Looking at a close-up detail of Graph #2, I picked "arbitrary" but  "best guess" start- and end-points for "two data sets running together":

Graph #5: Selecting (by eye) the Start and End Dates for the "running together" period.
The dots indicate Q1 1976 and Q1 1982. (The lines are indexed to 1977.)

Now we can compare three periods for the Growth Rate Difference: 1947Q2-1976Q1, 1976Q1-1982Q1, and 1982Q1-2018Q3.

Graph #6: Average Difference, RGDP Growth less Employment Growth, by Period

Again, this is based on quarterly data. Multiply the numbers above the columns by 4 to approximate annual growth rates. (It's not accurate, but it is close.) Rounded values: I get percentage point differences of 1.650 for the early period, 0.234 for the middle period, and 1.375 for the late period. Approximately one and two thirds, a quarter, and one and one third respectively.

The late period shows GDP, on average, growing about one and one third percentage points faster than employment. This is the period for which Jacob Assa shows his Figure 2 (my Graph #1 in this post) and says:

Recent research has suggested that the imputation of productive output for the FIRE sector in the national accounts has distorted GDP ... [It] drives a wedge between output (as measured by GDP) and employment trends, as visible in the phenomenon of ‘jobless growth’ observed after the three most recent recessions in the US (see figure 2).

I have moved one closing parenthesis mark from this excerpt. The original reads
"... a wedge between output (as measured by GDP and employment trends), ..."But I can only make sense of it as
"... a wedge between output (as measured by GDP) and employment trends, ..."Not to make a big deal of misplaced punctuation, but I want to admit that I changed Assa's sentence, in case his original is correct and I have mis-grasped his meaning.

The late period on my graph is the period during which "the imputation of productive output for the FIRE sector" has driven a wedge between output and employment, according to Assa. The early and middle periods, I therefore presume, do not show the influence of the imputation of productive output for the FIRE sector.

What Assa's claims mean, as I read it, is that the difference between RGDP growth and employment growth should get bigger as time goes by. The difference in recent years should be bigger than the difference in more remote years. And the difference in the middle period should be larger than in the early years, but less than in the late years. These expectations arising from Assa's argument are not fulfilled. I find this most disappointing, as I really do like Assa's story.