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.