My thoughts exactly!

I noticed the words cycle chart in a link to Mosler's, so I went looking. This graph, from John Burns Real Estate Consulting, LLC:

The text on the graph reads in part: "The shallow, low-growth trajectory of this expansion gives us confidence that this cycle has room to run."

That's it! That's what I was thinking. I wish I could have said it so clearly.

I've quoted John Taylor (from 2016) on this:

Because the economy has grown from the start of this recovery at a pace no greater than the prerecession trend, it has left a vulnerable gap of unrealized potential that can and should be closed with faster economic growth. In several key ways the US economy resembles an economy at the bottom of a recession...

I guess you could say that economic growth has to end in recession sometime, so the longer growth continues the more likely recession becomes. But if you look at it the way John Taylor did in 2016, growth didn't even start yet.

No cause for celebration, this

Under the heading World Trade as Percentage of Global GDP at Reddit:

Problem solving

From the unposted archives. Written back in March 2016.

Economist's View links to A Cheaper Way to Battle Recession at Bloomberg View. It's a Noah Smith post -- not that there's anything wrong with that.

I liked the post. It's well-organized, well written, and interesting. But that's not why I'm writing.

I'm not writing because I liked it. I don't even want to talk about what Noah talked about. I want to talk about something else. I want to talk about problem solving -- in case you couldn't tell by the title of mine today.

But in order to talk about problem solving, I need an example. Noah is my guinea pig, Noah's post.

In order to say what I have to say, I have to talk about what Noah says in his post. That's a problem for me, because Noah's is interesting. I might even say very interesting. And I don't want you to be distracted by it.


The title of Noah's post -- A Cheaper Way to Battle Recession -- seems to offer a solution to a problem. And it does, it does. I'll get to it in a minute. But, because of his title, we approach the text with a particular thought in mind: that Noah will be talking about a possible solution to a problem that does seem to need solving.

Here's his first paragraph:

What should the U.S. government do to fight recessions? What should it do to fight slow growth? This is the eternal question of so-called countercyclical policy. The two mainstream ideas are fiscal and monetary stimulus. The fiscal version works by having the government borrow and spend money, either on useful things like infrastructure, or by simply mailing people checks. The typical monetary variety works by having the Federal Reserve swap money for financial assets, which lowers interest rates.

Six sentences, and we are already deep in theory. I gotta give it to Noah: This is well-written stuff.

His next three paragraphs move us along quickly:

Paragraph 2: "Unfortunately, both of these methods have major drawbacks." Noah describes the drawbacks. Basically, the mainstream solutions no longer work.

Paragraph 3: "Because of these limitations, macroeconomists have been trying to dream up alternate ways of stimulating the economy." Noah presents two: the helicopter drop, and negative interest rates. He doesn't list problems with these. But he doesn't have to. I have problems with them already. Maybe you do, too.

Paragraph 4: Noah introduces the cheaper way to battle recession: "A third new idea is to have the government lend people money at very low interest rates" -- Miles Kimball's idea. Noah spends a few paragraphs with this one, and actually makes it sound pretty good. You know: interesting. We'd get low interest rates, he says, and the economy would benefit whether we paid back the loans or not.

Noah doesn't get into what happens when the government can no longer borrow at "just a bit more than 0.25 percent". And he doesn't spend a lot of time wondering whether it is wise to build into policy the notion that not paying back one's loans can be good. But he does bring up a couple potential problems with the idea of "national lines of credit".

Noah's concluding paragraph:

So there are serious political problems with using national lines of credit. But the evidence shows that it can give a big boost to demand, so the challenge is to find ways to minimize the political problems. Not only are national lines of credit a potential tool for recession-fighting, but they might even be useful for boosting growth to higher levels in a sluggish economy like the one the U.S. now is experiencing.

As I said: Interesting stuff.


My turn.

We don't like recessions and slow growth, Noah says. And we have ways to fight them. But these solutions no longer work, Noah says. Then he looks at some other solutions.

Noah identifies a problem and goes immediately to solutions. He never gets to the part where he actually figures out the cause of the problem.

Nobody does. That's why our solutions don't work.

Credit is an open sandwich: A layer of money on a layer of debt.

I just now googled we need credit for growth and turned up 436 million hits. The first is Credit Growth Drives Economic Growth, Until it Doesn’t by Richard Duncan, at the Daily Reckoning.

Actually, I googled that phrase just now because I googled it before, two years ago, and just now found it in my notes. Among the stuff that never got posted:

I googled the phrase we need credit for growth and got more than 2.8 million hits.

The first is Credit Growth Drives Economic Growth, Until it Doesn’t by Richard Duncan, from 2011. Good title. Pretty interesting article, too. But his opening is terrible. Two paragraphs, not really even relevant to his article, just sort of introductory. The second of those two paragraphs is completely wrong.

The first is right:

The single most important thing to understand about economics in the age of paper money is that credit growth drives economic growth.

The second is wrong:

Before the breakdown of the Bretton Woods international monetary system in 1971, there was a difference between money and credit. There no longer is.

There no longer is a difference between money and credit, he says. That's wrong. What I always say is "We use credit for money." Maybe that's what Richard Duncan had in mind. But the way I say it, it doesn't mean credit and money are the same. It means they are different. And I expect you to understand that the difference is a source of troubles -- is the source of troubles -- for our economy. Using credit for money creates problems, precisely because money and credit are different.

Stop. Stop everything. Stop the economy. Okay, now look around. I have money in my wallet: sixteen dollars. Two fives, six ones. I also have a credit card. Five of them, god help me. When we start up the economy again, I can buy something. Maybe I'll go out for breakfast.

If I pay for breakfast with my money, afterwards I have less money and more in my stomach. An exchange has been made. An exchange has been completed. My breakfast has been paid for. The transaction is finished.

It's not like that if I pay with credit.

If I pay for breakfast with credit, afterwards I have more in my stomach, but no less in my wallet. An exchange has been started, but not finished. The exchange will only be finished when I have paid for my breakfast. That may happen when I make my next monthly credit card payment. Or maybe it will happen ten years from now, after I've made some 120 interest payments on the breakfast I had on credit today.

The difference between money and credit is that using credit carries a cost, and money does not. What it comes down to really is how we get our money. Get it by working, and it is money. Get it by borrowing, and it is credit.

If it is money, you don't have to pay it back; if it is credit, you do.

If I borrow $16 and put it in my wallet it looks like money. But it comes with a debt. I have to pay the $16 back. Therefore, it is credit. When I spend it, I only spend the "money" part. The "debt" part stays with me. When I use credit to pay for my breakfast, they receive money even though I used credit. I spend the "money" but keep the "debt". The debt stays with me.

Money and credit are not the same. To the extent that money is created by credit use, debt is created when money is created. Debt is not created when money is earned.

Debt is created when money is created. Debt is not created when money is earned.

You are in competition with the Federal Reserve.

Years before the internet -- probably in the mid-80s -- I wrote to Milton Friedman and happened to describe interest rates as "the price of money".

No, Friedman replied: The interest rate is the price of credit, not the price of money.

I thought about that for probably ten years, and then one day it made sense: Money and credit are different things. "Credit" is the money that you pay interest on. "Money" is the money you don't pay interest on.

That understanding is the foundation of all my work. Money and credit are not the same. The difference? The cost of interest.


I've got near ten years in econ blogging. In ten years I don't know if anyone ever agreed with me, with Milton Friedman and me, on the difference between money and credit.

Nobody gets what I'm saying, because these days credit is money. Or at least, we use credit for money all the time. So everybody thinks credit is money, and everybody thinks I have it wrong. Like David Glasner thinks Milton Friedman had it wrong.

If you cannot see the difference between paying interest and not paying interest, you cannot see the problem I see. In order to describe the problem, I need different words for "money that has no interest cost" and "money that does have interest cost". I use the words money and credit.

If the two are different, it is surely confusing to call them both "money".


Anyway, this comes to me from Milton Friedman, this idea that interest is the price of credit. Also the basis for the idea, which is that money and credit are different, the difference being whether or not you pay interest on the money. Once again: If you pay interest on the money, the money is credit. If you don't, it's money.

Now most of us I guess don't really "have" money that we pay interest on. Maybe for an hour after you walk out of your bank with a new loan. But after an hour you've spent the money, and you don't "have" it any more.

Yeah. But that's micro, econ from the point of view of the individual and what's in his pocket. Look at it as macro, econ from the point of view of the economic system as a whole. It's not that you borrowed the money and spent it. It's that you created new money and put it into circulation. In this sense, you are just like the central bank. When you borrow and spend, you are putting money into circulation. When you receive income and pay down a debt, you are taking money out of circulation. You do the same things the Federal Reserve does. You are in competition with the Fed.

All during the time that your money is in circulation -- after you borrow and spend it, and until you pay it back -- you "have" money on which you pay interest. You don't have it in your pocket. You have it in circulation.

The least expensive way to add money to circulation is for the public sector do it. Least expensive for the private sector, and therefore most favorable to growth.

You never know how it's gonna turn out.

To convert Base Year 2000 prices to Base Year 2009 using annual data, I'll multiply by 81.883 and divide by 99.997, like this:

Graph #1: Base-Year Conversion

Those numbers are the year 2000 values from the two source datasets.

To convert Potential GDP from Base Year 2000 dollars to Base Year 2009, I have to switch the numbers around, like this:

Graph #2: 2007-vintage Potential GDP (red) restated in 2009 Dollars

My revised data (red) is a good match to recent data (blue) before 1980. After 1980, not so much. But the blue goes low after 2010 while red runs high, and that's right: After the Great Recession, Potential GDP was revised down.

And, apparently, the data between 1980 and 2010 was revised up.


Now I want to multiply my revised red data by the GDP Deflator, to convert real potential GDP to nominal potential GDP. And I'll change the blue line to show recent (nominal) GDP:

Graph #3: GDP (blue) and a 2007 estimate of Future GDP (red)

The two lines run close. The red runs a little low between 1990 and 2010, similar to Graph #2. But I want to focus more on the years since the Great Recession. The blue line, showing what actually happened, runs lower than the estimate made in 2007. The gap between them is a version of the "output gap" that people were talking about for most of the last 10 years.


So far there should be no surprises, even if you have not seen the numbers used as I'm using them here. I'm sure you've seen output gaps many times. Then too, converting from one base year to another is nothing special. And using potential GDP as an estimate of future GDP, well I'm sure I'm not the first guy to think of that!

But I do have a particular task in mind. And I used the numbers I did in the way I did so that I'd have what I need to complete my task.

You know how people always look at debt to GDP? This is my task. This is what I'm going to do. But I want to look at debt relative to GDP two ways: relative to GDP as things turned out (the blue line) and relative to GDP as it might have been if the economy didn't slow down after the Great Recession (red).

What debt to use? Doesn't matter. I'll use the Gross Federal debt, because so many people look at that one.

Here's what I got:

Graph #4: Federal Debt to GDP, for Actual GDP (blue) and 2007 Estimate (red)

Hm. Not as much difference as I expected. The difference is 8½% of GDP.

A Debt Smoothie

You've seen debt like this before:

Graph #1: Household Debt relative to Disposable Personal Income

Debt relative to income. It went up until the mid-60s, ran flat to the early '80s, uphill till 2000, uphill fast, and then down.
 
But sometimes, maybe, you want a more detailed look. I do. Sometimes I want to look at the change in debt relative to the change in income.

But when you look at change relative to change, you lose all the stability provided by the accumulation of debt and by the achievement of income. It becomes like trying to drive an old Volkswagen beetle that needs a front-end alignment and a rear-end alignment: Try as you might, you can't keep that thing going straight down the road.

With neither the accumulation nor the achievement to provide mass, the changes are no longer small. Change is all there is. The data value may suddenly double, or fall to zero, or even go negative. It can happen. It can happen with every new piece of data.

You can figure the ratio, but ratios are not well suited to data like that. What you end up with is not very meaningful:

Graph #2: Change in Household Debt relative to Change in DPI

What can we say of this graph? Something happened in 1953-54. Something happened in 1987. And something happened in 2016. Other than that, we can't say much.

Oh, and nothing seems to have to happened during 2008-2010.

Change relative to change does not make a useful graph. That's unfortunate, because it is a useful concept.

What to do? You can look at the change in debt and the change in income as separate lines on a graph:

Graph #3: Change in Household Debt (blue) and Change in DPI (red)

But this is too messy to be of much use. I see that both lines tend to go up until 2008 or so. But I don't know how much of that is real change and how much is just inflation. Using a ratio like Graph #2, the inflation cancels itself out of the picture. Not so with Graph #3.

On this graph, too, it is hard to see if income is gaining on debt or losing out to it -- except for a few years before 2009 when debt (the blue line) runs high, and a few years after 2009 when debt runs low. But that was obvious even on the first graph today.

Is there no better way to look at the change in debt relative to the change in income? Of course there is! I'm sure I'm not the first person ever to do it, but I did figure it out for myself. So, I get to write about it.

There may be better ways, but here's what I do. I take the change in debt and the change in income and give each one its own graph. Then I add a trend line to each, to smooth out the jiggies. For this trend line I use a Hodrick-Prescott and a low value for the smoothing constant.

Graph #4: Change in Household Debt (blue) and Hodrick Prescott with a Smoothing Constant of 15

Using the low value for the smoothing constant allows the HP to follow the data closely, jiggies aside. I use the same approach for debt (above) and income (below).

Graph #5: Change in DPI (blue) and Hodrick Prescott with a Smoothing Constant of 15

Next, I take the two smoothed lines and put them together on a new graph. (Doing this all on one worksheet simplifies the work in Excel.)

Graph #6: Smoothed Debt from Graph #4 (blue) and Smoothed Income from Graph #5 (red)

Graph #6 is the smoothed version of Graph #3 above. #6 is a little easier to read. Before about 1965, the lines are too close together to see anything. From 1965 to the mid-80s the red runs above the blue: Disposable Income rises faster than Household Debt. But not much faster. We called Graph #1 "flat" in those years.

After 1985, income (red) runs mostly below debt, and by 1998 income runs entirely below debt... until the crisis, when debt growth heads downhill fast.

Using these smoothed values, I can take another look at the "change in debt" to "change in income" ratio. The next graph shows the blue line from Graph #6 divided by the red line from the same graph.

Graph #7: Change in Household Debt relative to Change in Disposable Personal Income

This is the "smoothed data" version of Graph #2 above. This time we have something to see. The ratio runs very high between 2001 and 2007, then collapses down to values not shown, and finally rises back into the "normal" range.

But that's not what interests me most on this graph. I like to look at the time before things went bad. I like to look back to when things were going bad, before it was obvious, to see what was happening then.

In 1952 the ratio runs close to 1.00 on the vertical scale. That's a one dollar increase in debt for every dollar increase in Disposable Income. By 1970 the ratio is down near 0.50, a fifty-cent increase in debt for every dollar increase in income. During those years, especially after 1963, debt growth was slower than income growth.

A lot of that slow debt growth was no doubt due to the rising inflation of the time. But the first three peaks on Graph #7 (1954, 1960, and 1962) also show a trend of decrease, and that all happened before the time of the inflation.

Look now from the low of 1970 to just before the sharp increase of 2001. There is a mostly gentle increase for three decades. Between 1970 and 2000, the ratio climbed from 50 cents more debt, to almost $1.50 more debt, for every dollar of increased income.

On Graph #1, by the year 2000 the ratio had not yet reached one dollar. On Graph #7, it is near a dollar and a half. Why the difference? Because #7 shows only the new addition to debt. If debt is increasingly rapidly in the moment, #7 shows it.

Graph #1 adds the new debt to the old. But the old debt was accumulated when debt was growing at a slower pace. Adding new and old debt together drags the number down.

Graph #1 shows the accumulation, and shows it correctly. Graph #7 ignores the accumulation, and instead shows how fast the debt is growing at any particular point. Graph #7 shows that debt was growing faster in the year 2000 than we might have thought by looking at Graph #1.

Change relative to change is a useful concept.


I took Graph #7 and put some trend lines on it, just straight trend lines.

Graph #8: Change in Household Debt relative to Change in DPI, with Trend Lines

The early trend, shown in red, emerges from the data from 1952 Q1 thru 1970 Q1. The mid-years trend, green, is based on the data for 1970 Q2 thru 2000 Q4. I did not show a late-years trend, as the data is nothing but a jumble of craziness.

These trend lines emphasize the debt-to-income decline of the 1952-1970 period, and the debt-to-income increase since 1970. This is not what you would expect if you were only looking at Graph #1, which shows the whole accumulation of household debt relative to the whole achievement of disposable personal income.


Does it bother you? It bothers me. The red trend line points downward. But it is encouraged to point down by the inflation since the mid-60s. If we eliminate the inflationary years from the calculation, will the trend line still point downward?

A similar question arises for the green trend line. The first part of the mid-years data is held down by inflation. And the last part of the mid-years data is well known to be high. If we look at only the first part of the mid-years data, will the green trend line still point upward?

Good questions.

Working backwards from 1970 Q1, I eliminated data from the early trend until the red trend line changed from downward- to upward-pointing. Almost flat, actually. Then I added back the last data item I removed, to make the trend line point down again. The selected dataset runs from 1952 Q1 to 1964 Q1.

Working backwards from 2000 Q4, I removed data from the mid-years trend on the green data all the way back to 1982 Q4. The trend line still slopes upward.

Graph #9, with Trend Lines based on Smaller Subsets of the Data

The straight green trend line is based on the data shown in green. The straight red trend line is based on the data shown in red. The data shown in blue is not used in the trend line calculations.

The trend lines run pretty flat in Graph #9. But the red one still does slope down, and the green one still does slope upward. So I feel confident in saying that household debt tended to grow more slowly than disposable personal income in the 1952-1964 period, before the "Great Inflation" kicked in.

And I feed confident in saying that, the Great Inflation notwithstanding, household debt tended to grow faster than disposable personal income in the 1970-1982 period.

Graph #1 does show increase from 1970 to 1982. Not a lot of increase, but enough to agree with Graph #9. So I'm good with that. But I need one more look at the early years, because the red on #9 goes down, but the plot on #1 goes up.

Graph #10: Percent Change from Year Ago, CMDEBT & DPI, Annual Data

Debt growth declines; disposable income growth increases.

There ya go.

Some like it hot

Interesting as usual, Scott Sumner says Please, don't experiment with monetary policy. Sumner does not like

seeing an increasing number of pundits calling for policymakers to ... have (demand-side) policy run hot; to see just how much growth potential is out there... In my view it would be a mistake to experiment with monetary policy by not raising rates.

I'm thinking financial costs (as measured by debt service) are low, as they were low in 1993 when household debt was rising from 5% annual growth to over 7%. The change was a sign of increased consumer demand, a sign of a strong economy.

The increased borrowing pushed debt service up to 11% of disposable income by mid-1995. But debt service did not rise above 11.5% until third quarter 1999, pushed up then by rising interest rates. Debt service went above 12% by mid-2001.

Personal consumption expenditure peaked in March 2000. Unemployment stopped falling in April 2000, ran flat to the end of the year, and started rising. It was all downhill to the 2001 recession.

So that's what I was thinking when I got to the comment on Sumner's by Mark:

Is their argument that something like ‘computerization’ has driven up potential production such that we can sustain below 4% unemployment today? That seems very doubtful. We couldn’t even sustain it in the late 90s and it shot back up.

Not computers. Financial costs. Financial costs were low early in the 1990s. That's why there was money to spend on ‘computerization’, and that's why growth improved.

But we couldn't sustain that growth after financial costs rose above 11.5%, evidently, and that is why unemployment "shot back up" in 2001.

Financial cost is low like that, again today. There is a good chance that our economy can do better than anyone expects if rising interest rates don't prevent it.

I would remind policymakers that it is inflation they must fight, not economic growth.


I have a hard time reading graphs that have more than two lines on them. You might want to spend some time with these.

Graph #1: Growth of Personal Consumption Expenditures (red) and Household Debt (blue)

Personal Consumption Expenditure peaked in March 2000 and started to fall. Household borrowing soon followed, as did output.

Graph #2: Household Debt Service (red, right scale), Unemployment (blue), CPI (green),
Personal Consumption Expenditures again (purple) and the Federal Funds Rate (black)

Coupled with growing debt, rising interest rates pushed Debt Service upward until personal consumption began to fall. And that was the end of the good years.

Isn't it likely, Scott Sumner says,

that the Fed let the economy run too hot in 2000, and that this contributed to the subsequent recession? Business cycles are not just caused by contractionary mistakes (as some Keynesian accounts seem to imply) and they aren't just caused by expansionary mistakes, (as some Austrian accounts seem to imply.) They are caused by unstable monetary policy---more expansionary that average in some years, and less expansionary that average in other years.

You know, I'll go along with most of that. Not the "the Fed let the economy run too hot in 2000" part. "Hot" is not an economic explanation. "Hot" is for girls. But the rest of it, what causes business cycles, I can go along with. As long as Sumner lets me add to that list.

Scott Sumner spends his time thinking about money and the economy. But he never, ever stops to think that growing private debt creates a cost that can have a harmful effect on economic growth.

Interest rates, yeah, he thinks of that. But the debt on which interest is paid, and the size of that debt? Not ever does he consider it. It's too bad, really.

UK GDP per Capita 1700-2016

I just remembered: FRED has UK population and RGDP numbers all the way back to 1700, a hundred years further back than we were looking at for the US. You should see, my eyes are lighting up.

FRED has two measures of Real GDP for the UK going back to 1700: "at factor cost" and "at market prices". I don't know how you have "Real GDP at market prices". Market prices are nominal, no? GKToday explains that "factor cost" is what the factors cost, while "market prices" subtract indirect taxes and add subsidies (to the factor cost number, apparently). I suppose you could do all that figuring in nominals, and then take inflation out of the numbers to get reals. But it still seems like ill-considered terminology. Real GDP is never "at market prices" (except in the base year).

Anyway, I don't know which measure of Real GDP is the common one. No matter: I'll show both. Data copyright © Bank of England:

Graph #1: Real GDP per Capita, UK, 1700-2016  (Two Measures of Real GDP Shown)

Following the same method I've been using, I brought the data into Excel, added Hodrick-Prescott trend lines (again with 10,000 smoothing), and switched the vertical axis to log scale. Here is the result:

Graph #2: UK RGDP per Capita (two measures) and Smoothed H-P Trends

Again, arches are visible in the smoothed data. At least two arches; I think, three. Notice the disturbance in the source data around year 1710.

Figuring growth rates of the smoothed data for 20-year periods, as before, produces this result:

Graph #3: 20-year Growth Rates, showing 3 Arches & a 1790-1820 Stillborn Arch

This gets more interesting the more I look at it.

Suppose we take the arches from the US RGDPpC data and add them to the graph:

Graph #4: UK (red & blue) and US (green) 20-year HP(RGDPpC,10000) Growth

I'm gonna let you ponder this for a while.

Part 4 of 4

Economic Growth and Inequality

Last time I went to MeasuringWorth, I got data for both Real GDP and Real GDP per Capita, 1800-2016. This time I look at the "per Capita" numbers. I added a Hodrick-Prescott trend line with a smoothing factor of 10,000, same as before, and made the vertical axis a log scale again. It looks like this:

Graph #1: Real GDP per Capita, and Trend

The arches are still there. Bigger this time, I think. Here's the second graph:

Graph #2: 20-year Trend Growth of RGDP per Capita (14% more in 1820 than in 1800, etc)

The path of 20-year trend growth is still not linear. It will never be linear, no matter what some people say. But at least, if you put a linear trend line on it, the line goes up this time instead of down.

Yeah. But forget the "linear trend" nonsense. Look at the blue line. Look at it since the high point of 1953. It's all downhill since 1953, at a painful rate. We're down now at the bottom of all that, with no end in sight. You want to know why the world is bad as it is today? That 65-year downhill stretch tells you just about all you need to know.


Inequality? Yes, inequality, of course. That only reinforces what I'm saying. Our economy is growing terrible slow, and almost all the spoils go to the victors. I know. And then apply the same sort of inequality to the world as a whole, where we are the ones who are doing well, and most of the world looks upon us as "the one percent".

Of course it would be better if we reduce inequality. Better for some of us, at least. But you have to remember that the people who are doing well want their fair share just like the rest of us. And the blue line has been going downhill. So when they get theirs, things are normal for them and bad for the rest of us.

Apply that to the world as a whole. It explains everything, even terrorism.


Eliminating inequality cannot work as long as the blue line is going down, because when the blue line is going down, eliminating inequality makes everybody poor. The highest priority is not to eliminate inequality, but to improve economic growth.

Part 3 of 4

Second look at 20-year trend RGDP growth

Following up on yesterday's look at 20-year RGDP growth rates. Here's yesterday's graph:

Graph #1: 20-Year Trend RGDP Growth (140% more in 1820 than in 1800, etc.)

I took Real GDP in millions (from MeasuringWorth), put a Hodrick-Prescott on it with a lot of smoothing, and looked at growth of the smoothed data relative to 20 years before. It definitely does not show a straight-line trend of growth. And if you take the wavy blue line and put a straight line trend on it, that overall trend is clearly downhill.

In order to get a better idea what I was doing, I took that graph and put a second line on there to show the 20-year growth path of Real GDP without smoothing:

Graph #2: 20-year Growth of RGDP, Smoothed (blue) and Not (red)

Looks like the blue line is on fire.

That's an awfully jagged sawtooth. The blue does perhaps too much smoothing? But no, I don't think so. The red shows 20-year changes in Real GDP. You would expect the differences to be large. But the blue line doesn't smooth out those large jaggies. The blue line smooths out the much smaller year-to-year jiggies in RGDP.

(A jiggie is a small jaggie. A jaggie is a large jiggie. Apparently.)

Actually the Hodrick-Prescott calculation smooths out the relatively small disturbances in the RGDP data. And then the blue line takes the smoothed information and looks at 20-year changes in it. So I don't really think the blue line is overly smoothed.

I did use a much larger smoothing constant than you would normally use for annual data. But nowhere near the 400,000 that these guys used.

Part 2 of 4

So much for the notion that "trend real growth" is stable.

I went to MeasuringWorth and got annual data for U.S. Real GDP, 1800-2016. Added a Hodrick-Prescott trend line with a smoothing factor of 10,000. Changed the vertical axis to a log scale. It looks like this:

Graph #1: RGDP and Trend  (Vertical Scale is "Millions of 2009 Dollars")

I think I see arches in that thing. Actually, I'm not sure what I see. For a closer look I figured growth rates for 20-year periods, from 1820 to 2016. Looks like this:

Graph #2: 20-Year Trend RGDP Growth (1820 is 140% more than 1800, etc.)

Yup, arches. So much for the notion that "trend real growth" is stable.

Part 1 of 4

Kitov's warning

This is the most interesting econ topic I have seen in some time.

Ivan Kitov:

In this blog, we have discussed already [here and here] the incompatibility of real GDP data caused by the change in definition of the GDP deflator... in the USA - in 1977... One can see that the CPI inflation rate is approximately equal to the rate of the GDP deflator change multiplied by a factor of 1.22 since 1978...

Kitov adds:

This observation naturally leads to the assumption that real GDP in the United States is biased by the change in definition of the GDP deflator.

Yes. The data called "nominal" is based on actual prices. If you take "nominal GDP" and divide by the GDP Deflator, you get the so-called "real" values. And if you change the Deflator, you also change "real GDP".

The deflator is the price component of nominal GDP, and "real GDP" is the output component. If you make the price component bigger, the output component gets smaller. Oh, but that's not what we want! Making the price component bigger tells everyone that prices went up more than we thought, and output grew less. That's not what we want.

If you make the price component smaller, you're saying prices went up less than we thought, and output grew more. Yeah, that's better. That's what we want.

Guess which way the Deflator changed.


Okay. In Long-term economic growth is linear (10/24/14) Kitov refers to "the change in definition of the GDP deflator... in 1977".

In Is real GDP correct? (12/24/10) he says "All in all, the notion of real GDP is a virtual one and is highly biased by the change in its definition in 1979."

And in Real GDP is NOT correct (10/22/11) he refers to "the change in real GDP definition in 1978."

He's a little iffy on the date.

I don't know Kitov. But I do know that the methods for calculating inflation and unemployment have changed, and I know it is hard to find information on such changes, even on the internet. I remember a change in the calculation of the CPI back around Reagan's time, or maybe Clinton's. But my memory is fuzzy: It could have been the Deflator that changed, and maybe it was before Reagan. So I cannot dismiss Kitov's warning.

I see him saying

There is no direct statement about the reasons of the change in definitions in [Concepts and Methods of the U.S. NIPA], but we might guess that this is likely related to the introduction of a new methodology to evaluate the overall price inflation.

This bothers me. I need something definite. I cannot proceed based on a guess.

Kitov also says

there is no such macroeconomic measurable parameter as real GDP (see Concepts and Methods of the U.S. NIPA for details). There are two actually measured variables: nominal GDP and GDP deflator (price index). Real GDP is estimated using nominal GDP less the change in prices.

Yeah, that's what I thought; and I think it is how things once were. But Nick Rowe put doubt in my brain about how things are now. And there may have been changes in methodology such that Kitov is no longer correct on this point. I wish I could be sure.


In Is real GDP correct?, Kitov links to Concepts and Methods of the U.S. NIPA. The link brings up a list of Methodology Papers. The "Concepts and Methods" item is on the list. Also listed (with no link) is "A Guide to the National Income and Product Accounts of the United States", which, we are told, was replaced by the "concepts and methods" paper.

I remember the Guide. I remember making fun of the filename -- nipaguid.pdf -- for being DOS-compatible.

Under the heading Real Output and Related Measures on page 15 of the nipaguid (or page 16 of 28 in Adobe Reader) we read:

In addition to estimating the current-dollar market value of GDP, BEA estimates “real,” or inflation-adjusted, GDP and its components.

Yeh. But this gets v.e.r.y interesting:

The annual changes in quantities and prices in the NIPAs are calculated using a Fisher formula that incorporates weights from 2 adjacent years. For example, the 2003–04 change in real GDP uses prices for 2003 and 2004 as weights, and the 2003–04 change in prices uses quantities for 2003 and 2004 as weights.

There is a footnote attached to that last sentence, which says:

Because the source data available for most components of GDP are measured in dollars rather than in units, the quantities of most of the detailed components used to calculate percent changes are obtained by deflation. For deflation, quantities are approximated by real values (expressed, at present, with 2000 as the reference year) that are calculated by dividing the current-dollar value of the component by its price index, where the price index uses 2000 as the reference year.

They put it in the sentence twice, but the year they were using as the "reference year" is not the important thing. The important thing is that, for most components of GDP, the quantity numbers are figured by dividing the nominal value by the price index. RGDP is figured from the Deflator, not the other way around. Kitov is right.


Granted, the 28-page nipaguid has been replaced by the 447-page "Concepts and Methods" PDF. Yeah, yeah, nice.

On page 4-17 and 4-18 of the new PDF, they say that the "chain-type" index that they started using in 1996 is better than the older method, except it is "not additive". This seems to mean that if you add up the numbers, you get the wrong answer. Nice!

Get back on topic, Art. From the last paragraph on page 4-18:

For real GDP and its major components, BEA provides tables that present accurate estimates of contributions to growth rates that are based on chain-type quantity indexes rather than on the chained-dollar estimates (see the appendix).

Yeah, they said something like that in the nipaguid, too. I wonder if they still admit that the chain-type quantity indexes are "obtained by deflation".

They do! Page 4-19:

For most NIPA components, estimates of physical quantities are not available. Instead, “real” estimates—that is, estimates that exclude the effects of price change—are derived by “deflating” (dividing) the current-dollar value by appropriate price indexes.

They use chaining, rather than the pre-1996 method, to figure the price indexes. So, okay. But they're still doing all the work in prices, and converting to quantities. So remember: When they say their estimates of Real GDP are "based on chain-type quantity indexes": Yeah sure, but the quantity indexes are derived by “deflating” the current-dollar value by using price indexes.

They tell you again and again that "Real GDP" is based on quantities. But the fact remains that they figure the quantities by working backwards from actual prices and price indexes.

In follow-up comments to those linked above, Nick Rowe focuses intently on the calculations that are used:

I had thought that StatsCan uses the "Chain Laspeyres" index for GDP (see page 32). That's what I described above. But it sounds like they are maybe using Fisher, which is a geometric average of Laspeyres and Paasche.
...
In Laspeyres you first multiply today's vector of quantities by yesterday's vector of prices, to get real GDP today. Then you divide NGDP by RGDP to get the price index. (That's what I had thought they all did, so that RGDP comes before P.)

In Paasche you first multiply today's vector of prices by yesterday's vector of quantities to get a price index. Then you divide NGDP by P to get RGDP. (Which is the opposite).

And Fisher takes a geometric average of those two methods.

Okay. And I can see I'm going to have to put some numbers in Excel and see how those calculations work. (Not today.)

But notice that Nick takes the "vector of quantities" as a given. It is rarely a given: For "most" of the components of GDP, they figure the quantities by working backwards from actual prices and price indexes. And that's according to both the nipaguid and the "Concepts and Methods" PDF.

That's how I read it, but I'll leave a door open: If I have it wrong, let me know.

But don't focus on the smoke and mirrors of Laspeyres and Fisher and Paasche. Go back to the start. Go back before the part where they use "quantity indexes rather than chained-dollar estimates". Go back to where the quantity indexes are "derived by “deflating” the current-dollar value by appropriate price indexes". In most cases, the price indexes come before the quantity indexes.

Nick says:

I'm now starting to think that this is a non-question. Like debating whether the chicken or the egg comes first. You can do the math either way around. You can calculate P first, or you can calculate RGDP first. It doesn't matter.

It matters, Nick, because you can't use numbers you don't have.

I'm not saying we should avoid using quantity information, when we have it. I'm saying we don't usually have it.

And when the quantity information is calculated by working backwards from price information, let's not pretend that it really is quantity information.

So let's don't say the price index is figured by dividing nominal GDP by real GDP when, in most cases, if you trace things back far enough, it is real GDP that is figured by dividing nominal GDP by the price index.

Almost every case, I would bet.


I opened this discussion by observing that this concern of Ivan Kitov's is the most interesting econ thing I've come across in a long time.

But I had reservations about Kitov. I don't know him or his work.

I was concerned that he was "iffy" about his dates. I now understand that the change occurred in the 1990s, and data was changed for what were even then years past, back into the 1970s. So I'm no longer troubled to see that Kitov does not pin down the date precisely. That's the least important issue raised today.

I was concerned because Kitov was guessing about "the introduction of a new methodology", and I could not proceed based on a guess. I resolved this concern by checking the nipaguid and the "Concepts and Methods" PDF. Yes: The introduction of the "chain-type" calculation is the new methodology. I'll have to test that myself to prove to myself that the old methodology slash new methodology difference is the cause of the Deflator discrepancy that Kitov finds. But I'm good for now.

I was concerned that Kitov might be wrong when he said "Real GDP is estimated using nominal GDP less the change in prices." Because Nick Rowe challenged me on exactly that issue some than five years ago, and doubt lingered in my mind ever since. But I have now resolved this concern, barring a new challenge, by looking into the nipaguid and the other PDF.

I was concerned that my weak memory, which supported Kitov's argument, was weak and possibly flawed. I can resolve that concern right now:

Graph #1: The CPI and Five Vintages of GDPDEF, the GDP Deflator

The thin black line that extends all the way to the right is the Consumer Price Index (CPI). This is the one that the GDP Deflator formerly matched, according to Ivan Kitov. The other five lines on the graph all show the GDP Deflator, as it was at different dates in the past.  You can click the graph to see it bigger. Or you can click the text "Graph #1" in the caption below the graph to see the source page at ALFRED.

The blue line that extends all the way to the right is the most recent version of the Deflator. You can get some idea which line is which not only from the color, but also from the date where the line ends. Other than the CPI and this Deflator line, there are four other Deflator lines on the graph. These end in 1991, 1995, 1996, and 2000.

The fat red line that starts around 1960 and ends in 1991 (vintage 1991-12-04). This is the earliest "vintage" of the GDPDEF Deflator data available at the ALFRED site. It runs close to the CPI all the way to the end in 1991.

The bright blue line (vintage 1995-01-27) closely follows the fat red one and the CPI. The line ends in 1995.

The brown line (vintage 1996-01-19) was the first issue of 1996 data. You can see it reaches just a little past the end of the bright blue line. You can also see that it is lower than the 1995-01 vintage data -- but only back to about 1977 or so, apparently. As Kitov pointed out.

Note that the data issued in 1996 is different from the data issued in 1995, all the way back to the 1970s.

Not on the graph, the first-vintage data for the years 1997, 1998, and 1999 all follow the same path as the 1996 data shown.

The green line (vintage 2000-01-28) is the first year where the first vintage of the year has moved downward again, near to the path of the most recent vintage of the Deflator (blue).

In sum, the GDPDEF data follows the CPI until January 1995 (or possibly later that year). From 1996 to 1999 the data follows a "mid way" path, lower than the CPI but higher than the recent path of the Deflator. And since 2000, the data path is low, like the recent Deflator.

So Ivan Kitov is correct in saying the Deflator seems to depart the path of the CPI  in the latter 1970s. However, the change which caused that departure did not occur until 1996 or thereabouts. And then there was another change, in the year 2000.

So here's a question: If the change in the Deflator was caused by the change in methodology that required using "chain-type" calculations, then why do we see two changes, one around 1996 and one around 2000?

Dunno, buddy. Maybe later.


So much for the most interesting econ thing I've seen in a long time.

The most interesting non-econ thing I've seen recently? Stephanie Martini's eyes in Prime Suspect: Tennison.

Did Google Search just get stupid?

Could be a coincidence. Or maybe it's me. But it looks like Google Search no longer understands some of the things I expect it to understand. Some of the things that make it useful.

For example, yesterday I found by accident an article that noted a change in the way the GDP Deflator is calculated, a change that occurred around 1977 the guy said. A detail like that will sometimes grab my attention, and this one did. So this morning I sat down and Googled the change in definition of the GDP deflator.

Google turned up a definition of the Deflator from Investopedia, and one from Wikipedia, another from MyAccountingCourse.com, from study.com, from thoughtco.com, and, apparently, from another 533,995 sources. Yeah, because a definition is obviously the same as a change in definition. At least in the mind of Google Search.


Something very similar occurred with Google Search only yesterday. I thought it was odd then, but I figured it was probably me. But when it happens twice in two days, I no longer think it's me.

One day I ask for "trend growth" and it tries to give me "each year" growth data, and idle chatter on that. And the next day I ask for information about a change of definition, and it gives me half a million reps of a dumbed down definition. Nothing on how the definition or the calculation might have changed. Nothing historical.

So I have to ask: Did Google Search just get stupid?

When did we start using GDP?

I googled GDP trend since 1947. It gave me yearly growth rates. Google doesn't seem to understand the difference between "growth" and "trend". How can this be?

I'm trying to find info on long-term trend rates of growth, with little success so far. But I did find this:

There are more questions, but you get the idea.

That first question caught my eye: When did we start using GDP? Because if you read stuff from the 1970s and '80s they use GNP, not GDP. If you started doing econ in 1977 like me, that was before GDP, far as I'm concerned. But "GNP" does sound funny, these days.

The change occurred in the 1990s, 1996 I think. Maybe 1992. I clicked to see the answer to the question:

1695?

"... developed the method further in 1695." Before 1695? Yeah thanks, google.

Grain of salt.


The Atlantic says "In 1991 the government switched from the old GNP to the GDP".

Better yet, see the Survey of Current Business from August 1991, page 8:

Beginning with the upcoming comprehensive revision of the national income and product accounts (NIPA’s), BEA will feature gross domestic product (GDP), rather than gross national product (GNP), as the primary measure of U.S. production. This change in emphasis recognizes that GDP is more appropriate for many purposes for which an aggregate measure of the Nation’s production is used. GNP will remain a key aggregate in the NIPA’s and will continue to be published regularly.

Under the heading Why feature GDP? they explain:

GDP refers to production taking place in the United States. It is, therefore, the appropriate measure...

Why? Because it is appropriate. Of course. The bullshit is deep, some days.

Elect the Poor

Two stories are told. One is that government must help people. The other is that government must get out of the way.

Both stories are told by the wealthy.

Noah Smith still thinks financial crisis is a "random event"

"Failure to understand the cause" does not mean "These things occur at random". However, it may seem to mean that if you fail to understand the cause.

Noah Smith: Don't Forget What Causes a Recession

Why has the economy been growing uninterrupted for so long? Part of the reason is surely due to the severity of the Great Recession itself, coupled with the slowness of the subsequent recovery...

But there’s another reason too. The U.S. simply hasn’t been hit with any of the random events -- what economists call shocks -- that tend to tip countries into recession.

The first kind of shock, obviously, is a financial crisis.

Financial crisis = shock, Noah says, and shock = random event. Noah still thinks financial crisis is a "random event".

If Netflix was down as often as the government, they'd be out of business

RE: government shutdown.

The primary objective has two indivisible parts:

1. Put on a good face. Even if it goes against everything you stand for, you keep the government open.
2. Figure out where the problem is. We've been trying to eliminate the Federal deficit since Reagan. Since Nixon, probably. But we haven't been able to do it. Maybe we fail because we have the wrong solution.

If the power goes down, even momentarily, it is a problem: More people lose respect for government. More people see Fall-of-Rome as our destiny. More people expect the worst.

From the Washington Post:

Rand Paul thinks he is a man of principle. Yeah: principle without good judgement. If he's so concerned, then he more than anyone should be looking for a better solution. Alone in the Senate, he was willing to shut down the government:

... the federal government shut down when Sen. Rand Paul (R-Ky.) delayed the vote past midnight to complain about the budget deficit.

Don't do that to my country.


Again, the Washington Post:

The latest congressional breakdown came amid dispute over the spending deal, which earlier in the week had appeared primed for easy passage...

But it began to run into trouble Thursday, as House conservatives rebelled over excessive deficit spending and House liberals fumed that this bill, too, failed to protect “dreamers” who face losing deportation protections under the Trump administration.

I don't care what your objections are. You don't do that to my country.

Then, as an expected vote approached in the Senate, Paul began to throw up roadblocks...

“I can’t in all good honesty, in all good faith, just look the other way because my party is now complicit in the deficits,” Paul said on the Senate floor as evening pushed into night.

Paul himself made no apologies as he delivered one floor speech after another, casting himself as a lone defender of fiscal austerity...

A lone defender of fiscal austerity, with an ego bigger than the Federal debt. And no solution to the problem of deficits.

Pardon my French, but the man is an ass. He thinks we have deficits because B is greater than A, spending is greater than revenue. But that's only the arithmetic of deficits. It's not the cause.

To a man, economists will tell you the economy is too complicated for hobbyists like me to talk about. But the economists who set policy, they all buy the sadly simplistic "B is greater than A" story.

That story obviously does not explain the problem, as in 50 years of trying we have not solved the problem. Things only get worse.