A good economy doesn't crash. It goes bad first.

Via Mark Thoma, Claire Jones's How and why economics forgot Keynes’ warnings on panics at FT. Jones links to George Akerlof's 16-page PDF What They Were Thinking Then: The Consequences for Macroeconomics during the Past 60 Years. Akerlof's paper is a good read.

Akerlof, on financial crashes:

In the [early 1960s] push to assure acceptance of the dominant-paradigm Keynesian-neoclassical synthesis, a major macroeconomic question was left unresolved: what is the basic reason for very hard times that especially require fiscal or monetary stimulus? ... But in chapter 12 of The General Theory, on “the state of long-term expectation,” Keynes (1936) had suggested ... those bad times result largely from financial fragility. Famously, in that chapter, Keynes (1936, 140) analogized stock prices to the outcomes of a newspaper beauty competition.

Akerlof rejects the thought that the beauty contest analogy was just satire, and continues:

In concert with modern game theory, finance theorists have evolved a sophisticated understanding of why Keynes’s beauty contest is central to the theory of financial crash. A very simple game (adapted from Atkeson 2001) describes the skeleton of such models. In this game players have two choices: to continue to hold an asset or to sell it. With economic conditions sufficiently strong, the incentives to hold may be so strong that it pays to do so, even if everyone else sells. In this case, there is only one equilibrium: everyone holds, and the price of the asset remains high. With economic conditions at the opposite extreme, the incentives to hold may be so weak that it pays to sell, even if everyone else keeps it. Again, there is only one equilibrium: but this time everyone sells. But between these two extremes, in such a game, there is the possibility of an intermediate range with a threshold level of holders. If the number of holders exceeds the threshold, it pays to hold; if that number is below the threshold, it pays to sell. If such a model describes asset markets, financial equilibria are likely to be fragile...

Next, he offers three examples, among them the bank run:

In a bank run model (like that of Diamond and Dybvig 1983), if only the usual transactors are making withdrawals, there is not much reason to line up at the bank. But if others are lining up out of fears of its insolvency, there is reason to rush to be among those first in line to retrieve one’s deposit.

Like Keynes's beauty contest, a bank run depends less on what we think about conditions than on what we think other people think about conditions, and what we think they're thinking about what we're thinking. Tying this back to his topic, Akerlof points out that

such representation of financial markets had no substantial place in mainstream macroeconomics in the period leading up to the Great Recession.

Akerlof's paper is interesting, and quite convincing. Recommended reading.


The focus of economists on the major but unresolved macroeconomic question, "what is the basic reason for very hard times", is the wrong focus. A better question, and the answer too, arise from Akerlof's description of the game adapted from Atkeson:

• "With economic conditions sufficiently strong ..."
• "With economic conditions at the opposite extreme ..."
• And "between these two extremes".

What people do depends on economic conditions. When the economy is good, no one is thinking about bank runs. When the economy is bad, everyone is. If you keep the economy good, you don't have to worry about the basic reason for very hard times, because the very hard times never occur.

But here anyway is your "basic reason": Very hard times only occur as an outgrowth of plain old hard times. If you keep the economy good, you don't have hard times, so you don't get the very hard times. It's like having your cake, and then having some more.

You gonna tell me we don't know how to make the good times permanent? Well then, that's the question you need to work on, isn't it, instead of asking "what is the basic reason for very hard times?" This should be obvious, but apparently it isn't.


I wrote the above, then went looking for “Comment on Morris and Shin’s ‘Rethinking Multiple Equilibria in Macroeconomic Modeling.’”, the Atkeson PDF that Akerlof mentions. The Atkeson PDF led me to the Morris and Shin PDF.

I said:

What people do depends on economic conditions.

Morris and Shin open with this thought:

It is a commonplace that actions are motivated by beliefs, and so economic outcomes are influenced by the beliefs of individuals in the economy.

I go directly from economic conditions to economic actions. Morris and Shin go from beliefs about the economy to economic actions. Is there a difference between economic conditions and what people believe those conditions to be? Yes: It is possible that our beliefs are wrong. So the first task is to understand the economy, to get our beliefs in tune with actual conditions. Our second task, then, is to get back to the good times and stay there.

Of course, if you've been down so long it looks like up, you probably don't believe we can get back to good times. Okay. But maybe -- just maybe --that's an example of holding the wrong beliefs. Or, maybe I'm wrong. But the only way to tell is to understand the economy.


Akerlof contrasts "modern macroeconomic models and the models of financial crash", finding modern macro models inadequate. Good. But I think models of financial crash are also inadequate. You can't wait until there's a crash before you solve the problem. You have to catch the financial crash in its formative stages, years (or even decades) before the warning signs are obvious.

What I was working on yesterday

They interrupt me to advertise, now

It's 3:30 in the morning. I'm chasing down some odd detail of Federal debt. I download a file from FRED, in Excel format, and open it. I get the "protected view" warning, in case I'm too stupid to know that I just got the file off the internet and it might be full of virus. Yep, ya just cant trust that FRED. When am I gonna learn?

But there is an extra warning this time. Two yellow stripes. I have to stop what I'm doing and read it because god knows this one might be important.


"SUPPORT FOR OFFICE 2010 ENDING OCT 13, 2020"


"Stay supported by moving to Office 365 or other current versions of Office"


They suggest that I click "Tell me more"

Yeh, when hell freezes over. The stuff they call "support" I call mostly irrelevant. They want me to buy the new version of Excel. As an inducement, they're ending support for the version I use. That's extortion.

The internet is different now. The world is different now. They're squeezing blood from stones, and if they have to treat me like a stone to do it, it's okay with them.

Changes like this are everywhere. Changes like this, I think, are the result of 40 years of SUPPLY-SIDE favoritism in economic policy.

And now it's four in the morning and I lost half an hour. I think I shall send Microsoft a bill. My time? A trilllion dollars an hour.

The business interest expense deduction since TCJA

According to Thompson Greenspon,

Before Congress passed the Tax Cuts and Jobs Act (TCJA), most business-related interest expense was deductible... But for tax years beginning after 2017, the TCJA imposes a limit on business interest deductions, with exceptions...

Skipping over the exceptions -- businesses where the limit does not apply -- we come to this:

If the limit applies to your business, your annual deduction for business interest expense can’t exceed the sum of 1) your business interest income, if any, 2) your floor plan financing interest, if any, and 3) 30% of your adjusted taxable income.

Three factors determine the limit on business interest deductions. I want to look at all three (but not in order given).

First of all, what is "floor plan financing"? As Thompson Greenspon explains, it is used to stock automobile and appliance showrooms. The interest on this financing is deductible, it seems to me, because otherwise the types of business that use showrooms would have been hit harder by the tax than other types of business. So I guess it makes sense to allow the deduction for interest on floor plan financing. (Makes sense in the context of existing policy concepts, I mean.)

Floor plan financing aside, then, and exceptions aside (and leaving "your business interest income" for last), the business interest expense deduction is limited to 30% of adjusted taxable income. 30% seems like a lot to me. It's just the interest that's deductible, not the principal repaid. I don't have numbers for business sector debt service, but for households, debt service is about 10 to 12% of Disposable Personal Income (DPI). Say 12 percent. That includes interest and principal.

In the years since the crisis, interest has been about 50% of debt service (or 6% of DPI) with principal making up the rest. For most of the 1990s, interest was about 64% of debt service, or 7.68% of DPI. I'll look at both numbers.

Taxable Income (from the Individual tax form) is about 50% of DPI. So for $100 of DPI, Taxable Income is about $50. If we were talking business income, the interest deduction would be limited to 30% of that, or $15.

For $100 of DPI, $50 Taxable, the current number (6% of DPI) is 12% of Taxable Income and is below the limit on interest deductions. The number for the 1990s (7.68% of DPI, or $7.68) is 15.36% of Taxable Income, but it's still only $7.68. That's still well below the $15 limit. All of that interest expense would be deductible. If the interest costs were twice as much, almost all of it would still be deductible. Based on this godawful crude estimate, the limit on the business interest deduction tells businesses: We encourage you to borrow more today, but don't borrow more than twice as much as you did in the 1990s.

The limit on business interest deductions allows interest costs to rise to twice the level that household interest costs reached in the 1990s (relative to taxable income). It doesn't cap them at a lower level. It sets the limit high enough that it shouldn't impinge on the borrowing business wants to do. I'm disappointed.

Remember, this estimate is based on household debt service numbers, not business numbers. And I can't even guess if business debt service is comparable to household debt service. But I had to look.


We have not yet looked at the other limit on business interest deductions noted by Thompson Greenspon. So far, all of the interest on floor plan financing is deductible, plus all but the highest reaches of annual business interest expenditure. If you still have more interest expenses you want to deduct, you can turn to a third option: the limit set by your business interest income.

Remember, you get to add the three limits together to find your maximum interest deduction.

The Thompson Greenspon page explains this third option:

you can use an unlimited amount of business interest expense to offset business interest income

So when you're figuring out your taxes, you take all of the interest you paid for your floor plan financing and deduct the whole thing.

Then add up all your other interest expenses and compare that to your interest income. If the expenses are less (or equal to) the income, all those expenses are deductible. If not, deduct the amount equal to your interest income, and ponder the balance.

If the balance of your interest expenses is not over 30% of your adjusted taxable income, deduct it all. But anything over 30% is taxable.

By the way, I'm not offering advice on doing your taxes. I'm just trying to figure out what happens with interest expenses.

Seems to me this plan will do little to reduce the reliance on credit by business. Look at that one item: "You can use an unlimited amount of business interest expense to offset business interest income," Thompson Greenspon says. The more interest expense you have, the more interest income you can write off. The more money your business earns by interest, as opposed to producing and selling real output, the more of your interest expenses you can deduct. The business is rewarded for engaging in finance rather than the production of output.

 That's not an incentive to to reduce your financial expenses. It's an incentive to take your money out of your factories and start lending it. Come to think of it, Apple has been advertising its new credit card lately. A consequence of TCJA, perhaps?

Politics and the economy

Lane Kenworthy, in Voters, groups, parties, and elections:

In a representative democracy, a key goal is to ensure that government is “for the people” — that it does what citizens want.

... to ensure that government does what citizens want. Of course. But a word of caution is in order.

Near the end of the must-see 1975 movie Three Days Of The Condor, there is a conversation between good guy Joe Turner (Robert Redford) and Higgins, the bad guy (Cliff Robertson).

Spoiler Alert: Maybe you should watch the movie before you finish reading this.

The conversation starts about 1:51 into the movie. Here's the relevant part:

HIGGINS: It's simple economics. Today, its oil. In 10 or 15 years it'll be food, plutonium. Maybe even sooner. What do you think the people will want us to do then?

TURNER: Ask them.

HIGGINS: Not now, then. Ask them when they're running out. Ask them when there's no heating. When their engines stop. When people who've never known hunger go hungry. They won't want us to ask them, they'll just want us to get it.

Higgins is talking economics. What he's doing, though, is politics: He's waiting for the economy to get bad enough that voters will vote the way he wants.

"the mundane economic issues that wear people down and cause them to rise up"

Via Economist's View, from Joseph E. Stiglitz: The End of Neoliberalism and the Rebirth of History. The opening paragraphs:

At the end of the Cold War, political scientist Francis Fukuyama wrote a celebrated essay called “The End of History?” Communism’s collapse, he argued, would clear the last obstacle separating the entire world from its destiny of liberal democracy and market economies. Many people agreed.

Today, as we face a retreat from the rules-based, liberal global order, with autocratic rulers and demagogues leading countries that contain well over half the world’s population, Fukuyama’s idea seems quaint and naive. But it reinforced the neoliberal economic doctrine that has prevailed for the last 40 years.

The credibility of neoliberalism’s faith in unfettered markets as the surest road to shared prosperity is on life-support these days. And well it should be. The simultaneous waning of confidence in neoliberalism and in democracy is no coincidence or mere correlation. Neoliberalism has undermined democracy for 40 years.

At that point, I was sayin GO, JOE!

Myself, I'm not comfortable pointing the finger at a large group of economists that I would prefer to have on my side. Other than that, though, Stiglitz is right: The economy has undermined democracy.

The economy drives politics, always. People almost always have that backwards.


There was no greater economist than Maynard Keynes, but there was one wise enough to warn of the potential excesses of Keynesian economics. Hayek, in The Road to Serfdom:

So long as we can freely dispose over our income and all our possessions, economic loss will always deprive us only of what we regard as the least important of the desires we were able to satisfy. A "merely" economic loss is thus one whose effect we can still make fall on our less important needs, while when we say that the value of something we have lost is much greater than its economic value, or that it cannot even be estimated in economic terms, this means that we must bear the loss where it falls. And similarly with an economic gain. Economic changes, in other words, usually affect only the fringe, the "margin," of our needs... This makes many people believe that anything which, like economic planning, affects only our economic interests cannot seriously interfere with the more basic values of life.

This, however, is an erroneous conclusion.

Economic planning would not affect merely those of our marginal needs that we have in mind when we speak contemptuously about the merely economic. It would, in effect, mean that we as individuals should no longer be allowed to decide what we regard as marginal.

The essence of his argument: Economic issues are not matters of secondary importance. They are more significant than they seem -- more significant, even, than political issues. The economy drives everything. If the economy goes to shit, everything goes to shit.


If Hayek can't convince you, maybe Hayward can: Gene Hayward, a high school economics teacher. His students, he says,

want to believe the "Brave Heart" fight for freedom mantra version of events. I show them examples of the mundane economic issues that wear people down and cause them to rise up. The rebellion usually morphs into a cry for freedom and liberty and blah, blah, blah, but it was born of price instability.

Or maybe this guy. Of him, Time magazine said:

Keynes feared inflation, and warned that "there is no subtler, no surer means of overturning the existing basis of a society than to debauch the currency."

Neoliberalism, Stiglitz said. Economic Control and Totalitarianism, Hayek said. Rebellion, Hayward said. Overturning society, Keynes said. Troubling political issues, deeply entangled with economic troubles. As noted by Stiglitz, Hayek, Hayward, and Keynes. And me.

The economy drives politics.

(If you want to say politics drives the economy, fine. But don't forget it also works in the other direction. What was it Stiglitz said? He said it's "no coincidence or mere correlation. Neoliberalism has undermined democracy...")

M.A. FINAL ECON: Gordon's Triangle

From M.A. FINAL ECONOMICS by Sehba Hussain and edited by Professor Shakoor Khan:

2.6.3 Gordon's triangle model
Robert J. Gordon of Northwestern University has analysed the Phillips curve to produce what he calls the triangle model, in which the actual inflation rate is determined by the sum of
1. demand pull or short-term Phillips curve inflation,
2. cost push or supply shocks, and
3. built-in inflation.
The last reflects inflationary expectations and the price/wage spiral.

(That's word-for-word the same as the haicuan blog Notes.)

Caught my eye because they say inflation is "the sum of" the three components. Leads me to think that if I was smart enough I could calculate inflation from money growth and stuff like that. And maybe that Robert Gordon has already figured out the calculation, so I don't have to be that smart.

I have to point out that economists brusquely dismiss the concept of cost-push inflation, but are highly focused on "supply shocks" as an explanation of almost everything. You know: oil as a supply shock, causing inflation in the 1970s. But tsk-tsk, don't call it "cost-push" inflation.

And yet item 2 in the triangle model description above says "cost push or supply shocks" as if these are two different names for the same phenomenon! (Note that in item 1, "demand pull" and "short-term Phillips curve inflation" are clearly offered as two different names for the same phenomenon.)

There's more on Gordon's Triangle elsewhere in the FINAL ECON paper:

2.3 KEYNESIAN VIEW
Keynesian economic theory proposes that changes in money supply do not directly affect prices, and that visible inflation is the result of pressures in the economy expressing themselves in prices. The supply of money is a major, but not the only, cause of inflation.

There are three major types of inflation, as part of what Robert J. Gordon calls the "triangle model":
Demand-pull inflation is caused by increases in aggregate demand due to increased private and government spending, etc. Demand inflation is constructive to a faster rate of economic growth since the excess demand and favourable market conditions will stimulate investment and expansion.

Cost-push inflation, also called "supply shock inflation," is caused by a drop in aggregate supply (potential output). This may be due to natural disasters, or increased prices of inputs. For example, a sudden decrease in the supply of oil, leading to increased oil prices, can cause cost-push inflation. Producers for whom oil is a part of their costs could then pass this on to consumers in the form of increased prices.

Built-in inflation is induced by adaptive expectations, and is often linked to the "price/wage spiral". It involves workers trying to keep their wages up with prices (above the rate of inflation), and firms passing these higher labor costs on to their customers as higher prices, leading to a 'vicious circle'. Built-in inflation reflects events in the past, and so might be seen as hangover inflation.

Demand-pull theory states that the rate of inflation accelerates whenever aggregate demand is increased beyond the ability of the economy to produce (its potential output). Hence, any factor that increases aggregate demand can cause inflation. However, in the long run, aggregate demand can be held above productive capacity only by increasing the quantity of money in circulation faster than the real growth rate of the economy. Another (although much less common) cause can be a rapid decline in the demand for money, as happened in Europe during the Black Death...

(That's not quite word-for-word from Wikipedia.)


At IDEAS: A Consistent Characterization of a Near-Century of Price Behavior, by Robert J. Gordon, 1980. From the abstract:

This paper develops a single econometric equation that can explain most of the variation in the aggregate U.S. rate of inflation during the period between 1892·and 1978.

No shit. And this:

The formation of price expectations changed completely after 1950 from regressive expectations appropriate under a gold standard to extrapolative inertia-dominated expectations appropriate under a fiat money standard and postwar long-period wage contracts.

Interesting, and it sounds right. It has occurred to me that when prices were tied to gold, there wasn't much that could be done to boost the quantity of money. But when money's connection to gold became tenuous, it became possible to increase the Q of M. So I think we should expect to see the thing that Robert Gordon points out here.

Related, from the text:

The EPC [Expectational Phillips Curve] explanation, which in its most general form relates price change to expected inflation and the level of detrended output, obscures the fact that price change has been much more closely related to the contemporaneous rate of change of detrended output.

And:

... while the formation of inflation expectations has shifted in the postwar years,
the cyclical impact of detrended output changes has not.

And on page 4:

... under a gold standard we might find the price level jumping up and down around a stable or slowly moving trend ... But under the postwar fiat-money standard, few increases in the price level have been reversed.

//

Here's a place to start:

Over the near-century of annual data studied here, a change in output has shown a remarkably consistent tendency to be associated in annual data with a simultaneous change in the price level of about one-half as much. Stated another way, nominal GNP changes have been divided consistently, with two-thirds taking the form of output change and the remaining one-third the form of price change.

If true, that's a pretty interesting rule of thumb; could be as useful as Okun's law. But I've heard of Okun's and I haven't heard of Gordon's law, so maybe Gordon's law didn't hold up. I guess I'll take a look at the data.

Yeah, but not today.

M.A. FINAL ECON: "the whole 800 years leading up to 1820"

From section 2.4: HISTORY OF BALANCE OF PAYMENTS ISSUES in M.A. FINAL ECONOMICS by Sehba Hussain, edited by Professor Shakoor Khan:

From about the 16th century, Mercantilism was a prevalent theory influencing European rulers, who sometimes strove to have their countries out-sell competitors and so build up a "war chest" of gold. This era saw low levels of economic growth; average global per capita income is not considered to have significantly risen in the whole 800 years leading up to 1820, and is estimated to have increased on average by less than 0.1% per year between 1700-1820.

First impression: I like that last sentence, so rich with stats.

Second thought: I wonder if this is original writing, or borrowed.

Borrowed.

M.A. FINAL ECONOMICS at studyres.com

In the If by deliberate policy search I did the other day, something that looked interesting turned up: M.A. FINAL ECONOMICS at studyres.com.

I poked around a little, finding enough that I wanted to come back for a more thorough look.

I found something on Robert J. Gordon and his "triangle model" of inflation. I heard of that 20 years ago or more, and had in the back of my mind ever since. Never went looking for it, but now here it was, quite by accident. So I made a note and kept the link to the M.A. FINAL ECONOMICS page handy, planning to get to it -- some time in the next 20 years maybe.

Then I came across the names Samuelson and Solow, together like that: a reference to their 1960 article that I've been on about lately. So I added to my note:

I DON'T KNOW WHAT THIS [PAGE] IS BUT IT MIGHT BE INTERESTING

While I was there I read the first sentence of the S&S part:

2.7 SAMUELSON AND SOLOW’S APPROACH
As this model says, it is not possible on the basis of a priori reasoning to reject either the demand-pull or cost-push hypothesis, or the variants of the latter such as demand-shift...

Ah, the good stuff. It struck me as a paraphrase, at first. But I remembered the words "a priori reasoning" and I remember S&S not rejecting "either the demand-pull or cost-push hypothesis, or the variants". Seemed like a lot of identical words, for one sentence. Sort of a relaxed paraphrase, or maybe a plagiaphrase. Couldn't say for sure, but I had to go back to my "I don't know what this is" note and double-underline it.

That was two or three days ago. I'm back to it now to see what I saw. I compared the M.A. FINAL ECON article to the Samuelson and Solow article that I recently extracted from the Joint Economic Committee report and put on the blog. The two are not identical after all. I've taken a few paragraphs of each, and highlighted the differences; I made the paragraph breaks the same for both, to make reading and comparison easier. The original paper from 1960 on the left; the M.A. FINAL ECON paper on the right:

IV

2.7 SAMUELSON AND SOLOW’S APPROACH

We have concluded that it is not possible on the basis of a priori reasoning to reject either the demand-pull or cost-push hypothesis, or the variants of the latter such as demand-shift. We have also argued that the empirical identifications needed to distinguish between these hypotheses may be quite impossible from the experience of macrodata that is available to us; and that, while use of microdata might throw additional light on the problem, even here identification is fraught with difficulties and ambiguities. Nevertheless, there is one area where policy interest and the desire for scientific understanding for its own sake come together. If by deliberate policy one engineered a sizable reduction of demand or refused to permit the increase in demand that would be needed to preserve high employment, one would have an experiment that could hope to distinguish between the validity of the demand-pull and the cost-push theory as we would operationally reformulate those theories. If a small relaxation of demand were followed by great moderations in the march of wages and other costs so that the social cost of a stable price index turned out to be very small in terms of sacrificed high-level employment and output, then the demand-pull hypothesis would have received its most important confirmation. On the other hand, if mild demand repression checked cost and price increases not at all or only mildly, so that considerable unemployment would have to be engineered before the price-level updrift could be prevented, then the cost-push hypothesis would have received its most important confirmation. If the outcome of this experience turned out to be in between these extreme cases-as we ourselves would rather expect-then an element of validity would have to be conceded to both views; and dull as it is to have to embrace eclectic theories, scholars who wished to be realistic would have to steel themselves to doing so. Of course, we have been talking glibly of a vast experiment. Actually such an operation would be fraught with implications for social welfare. Naturally, since they are confident that it would be a success,the believers in demand-pull ought to welcome such an experiment. But, equally naturally, the believers in cost-push would be dead set against such an engineered low-pressure economy, since they are equally convinced that it will be a dismal failure involving much needless social pain...

As this model says, it is not possible on the basis of a priori reasoning to reject either the demand-pull or cost-push hypothesis, or the variants of the latter such as demand-shift. UTe have also argued that the empirical identifications needed to distinguish between these hypotheses may be quite impossible from the experience of macro data that is available to us; and that, while use of microdot might throw additional light on the problem; even here identification is fraught with difficulties and ambiguities. Nevertheless, there is one area where policy interest and the desire for scientific understanding for its own sake come together. If by deliberate policy one engineered a sizable reduction of demand or refused to permit the increase in demand that would be needed to preserve high employment, one would have an experiment that could hope to distinguish between the validity of the demand-pull and the cost-push theory as we would operationally reformulate those theories. If a small relaxation of demand were followed by great moderations in the march of wages and other costs so that the social cost of a stable price index turned out to be very small in terms of sacrificed high-level employment and output, then the demand-pull hypothesis would have received its most important confirmation. On the other hand, if mild demand repression checked cost and price increases not at all or only mildly, so that considerable unemployment would have to be engineered before the price level up drift could be prevented, then the cost-push hypothesis would have received its most important confirmation. If the outcome of this experience turned out to be in between these extreme cases-as we ourselves would rather expect-then an element of validity would have to be conceded to both views; and dull as it is to have to embrace eclectic theories, scholars who wished to be realistic would have to steel themselves to doing so. Of course, we have been talking glibly of a vast experiment. Actually such an operation would be fraught with implications for in demand-pull ought to welcome such an experiment. But, equally naturally, the believers in cost-push would be dead set against such an engineered low-pressure economy, since they are equally convinced that it will be a dismal failure involving much needless social pain...

Okay. To tie this all together I want to point out that Samuelson and Solow said "it is not possible on the basis of a priori reasoning to reject either the demand-pull or cost-push hypothesis". And the M.A. FINAL ECON paper says it. And I say it, and maybe you also, I dunno. But Paul Volcker most definitely did not say it.

Gone was the notion of cost-push versus demand-pull. Volcker implicitly accepted that rising inflation was caused by “demand-pull”.

A Key Quote from Samuelson and Solow (1960)

The full thought, from section IV of Samuelson and Solow (1960):

"If by deliberate policy one engineered a sizable reduction of demand or refused to permit the increase in demand that would be needed to preserve high employment, one would have an experiment that could hope to distinguish between the validity of the demand-pull and the cost-push theory as we would operationally reformulate those theories."

I have to go back and check what they mean by "as we would operationally reformulate those theories", but Paul Volcker performed that experiment as Chairman of the Federal Reserve. Marcus Nunes writes:

On becoming chairman of the Fed, Volker challenged the Keynesian orthodoxy which held that the high unemployment high inflation combination of the 1970´s demonstrated that inflation arose from cost-push and supply shocks – a situation dubbed “stagflation”...

To Volker, the policy adopted by the FOMC “rests on a simple premise, documented by centuries of experience, that the inflation process is ultimately related to excessive growth in money and credit”.

This view, an overhaul of Fed doctrine, implicitly accepts that rising inflation is caused by “demand-pull” or excess aggregate demand or nominal spending.

Josh Hendrickson concurs:

... Relying on public statements and personal diary entries from Arthur Burns, I demonstrate that there is little evidence that the Federal Reserve was less concerned with inflation during the 1970s. Rather, the view of Burns and others was that inflation was largely a cost-push phenomenon. Burns thought that incomes policies were necessary to restore price stability and stated that “monetary and fiscal tools are inadequate for dealing with sources of price inflation that are plaguing us now.”

The shift in policy, beginning with Paul Volcker, was an explicit attempt to stabilize inflation expectations and this was done deliberately at first through monetary targeting and ultimately through the stabilization of nominal income growth. Gone were notions of cost-push versus demand-pull inflation. The Fed simply assumed accountability as the creator of inflation.

The Fed limited the growth of the quantity of money and limited the growth of nominal income. Volcker ran the experiment. Gone was the notion of cost-push versus demand-pull. Volcker implicitly accepted that rising inflation was caused by “demand-pull”.

Even before the experiment was over, cost-push was no longer considered valid theory. That was Volcker's premise. Today, the cost-push idea is taken as some kind of joke -- or quaint, perhaps, but definitely wrong. In comments on Hendrickson's post, Nick Rowe quoted the part about Burns thinking inflation was largely a cost-push phenomenon. and replied:

People forget (and maybe younger people never knew) just how common that view was in the 1970’s. It was common among economists as well as the general population. It was almost the orthodoxy of the time, IIRC. Tighter monetary policy would just raise interest rates, which would increase costs, and make inflation even worse.

Hendrickson agreed with Rowe. Nunes agreed with Hendrickson's post. And Bill Woolsey wrote:

There were really _economists_ who thought that “tighter money” would raise inflation through a cost-push mechanism?

I got in on the action and responded with a yup to Woolsey, quoting Robert V. Roosa, past vice president of the New York Fed, and Undersecretary for Monetary Affairs under President John F. Kennedy. Roosa, from Fortune magazine, September 1971:

And yet another factor has been the undue reliance on restrictive monetary policy to limit demand, with the perverse result of making interest rates themselves a major cost-push force.

Roosa's kind of thinking has been almost universally dismissed by economists. That dismissal is a case where the old ideas ramify into every corner of our minds.

In the US, in 1952, interest costs amounted to 5.67% of GDP, a pretty low number. Sixty years later in 2012, interest costs came to 15.42% of GDP. That's a difference of almost ten percent of GDP. If our reliance on credit hadn't increased, and our interest costs still amounted to 5.67% of GDP, prices could have been almost 10% lower than they actually were in 2012 -- with the difference not involving wages, but only interest costs.

Oh by the way: in 1952 the effective interest rate in the US was 4.35%. In 2012 that rate was 4.36%. Almost identical. (That's why I picked the years 1952 and 2012.) The interest rate was the same, but the interest cost was $160 billion more in 2012 than 1952. Why? Because there was more debt in 2012. A lot more debt.

Paul Volcker on the tradeoff

From The Federal Reserve’s “Dual Mandate”: The Evolution of an Idea (PDF):

Volcker defended the Fed’s actions in 1981 testimony to the Senate Committee on Banking, Housing, and Urban Affairs:

I am wholly convinced—and I think I can speak for the whole Board and whole Open Market Committee—that recognizing that that objective for unemployment [4 percent] cannot be reached in the short run—the kinds of policies we are following offer the best prospect of returning the economy in time to a course where we can combine as full employment as we can get with price stability.

I bring in price stability because we will not be successful, in my opinion, in pursuing a full employment policy unless we take care of the inflation side of the equation while we are doing it. I think that philosophy is actually embodied in the Humphrey-Hawkins Act itself. I don’t think that we have the choice in current circumstances—the old tradeoff analysis—of buying full employment with a little more inflation.

We found out that doesn’t work, and we are in an economic situation in which we can’t achieve either of those objectives immediately. We have to work toward both of them; we have to deal with inflation. And the Federal Reserve has particular responsibilities in that connection.

The Volcker Experiment

From A Dynamic Factor Model of the Yield Curve as a Predictor of the Economy at the website of the Federal Reserve Board:

In October 1979, the Federal Reserve Bank adopted new operating procedures shifting their emphasis from targeting the federal funds rate to the quantity of non-borrowed bank reserves in order to achieve the desired rates of growth in the monetary aggregates.

Before October 1979 they focused on the Federal Funds Rate. In October 1979, under Volcker, they switched to a focus on "the quantity of non-borrowed bank reserves". They switched, that is, to a focus on the quantity of money.

From Understanding Open Market Operations (PDF) by M. A. Akhtar, at the St. Louis Fed:

The formulation of monetary policy has undergone significant shifts over the years. In the early 1980s, for example, the Federal Reserve placed special emphasis on objectives for the monetary aggregates as policy guides for indicating the state of the economy and for stabilizing the price level. Since that time, however, ongoing and far-reaching changes in the financial system have reduced the usefulness of the monetary aggregates as policy guides.

"Monetary aggregates" is a reference to various measures of the quantity of money. Akhtar says that changes in the financial system reduced the usefulness of the quantity of money as a policy tool.

Changes in the financial system? What changes? The expansion of credit, obviously. Oh, a million other things, of course, but in brief the end result was the expansion of credit.


Not sure of the timing of the Fed's shift away from monetary aggregates. Wikipedia says

in 1984 the Federal Reserve officially discarded monetarism

Oh -- that's footnoted to the Huffington Post which, in my experience, is not a reliable source. Here's Krugman and Wells from page 896 from their Economics text at Google Books:

In the late 1970s and early 1980s the Federal Reserve flirted with monetarism. For most of its prior existence, the Fed had targeted interest rates, adjusting its target based on the state of the economy. In the late 1970s, however, the Fed adopted a monetary policy rule and began announcing target ranges for several measures of the money supply. It also stopped setting targets for interest rates. Most people interpreted these changes as a strong move toward monetarism.

In 1982, however, the Fed turned its back on monetarism. Since 1982 the Fed has pursued a discretionary monetary policy, which has led to large swings in the money supply. At the end of the 1980s, the Fed returned to conducting monetary policy by setting target levels for the interest rate.

Other sources reference a somewhat later end-date. For example, this from What Was Behind the M2 Breakdown? at the New York Fed:

A deterioration in the link between the M2 monetary aggregate and GDP, along with large errors in predicting M2 growth, led the Board of Governors to downgrade the M2 aggregate as a reliable indicator of monetary policy in 1993.

And finally, while looking up the above history I found Friedman's change-of-heart statement at Wikiquote, referenced to the Financial Times of 7 June 2003:

The use of quantity of money as a target has not been a success. I'm not sure that I would as of today push it as hard as I once did.

"Oops."

Household Debt Service by Vintage since 1999

"Looks like they do some significant revising of the debt service data. Maybe I'll do a post on that. Maybe I will." -- me

It was easy. Went to FRED TDSP and took the link to ALFRED. They have "vintages" of the debt service data beginning in 1999, with a new one every three months or so, up to the present. I put the first 10 of em into a graph, then figured I'd better save it. So I clicked DOWNLOAD. The first option ALFRED offers is "All Vintages (data)". Whoa, exactly what I wanted. Got it as an Excel file. Didn't need to do em 10 at a time.

I didn't know how many lines I could plot in one graph in Excel. Tried columns A to Z, and it worked. So then I tried em all, column A to column CD. And it worked.

I wrote a little VBA routine to make all the lines thin and black; the heart of it is here:

Dim s As Object: For Each s In ActiveChart.SeriesCollection
    s.Select
    With Selection.Border
      On Error Resume Next
        .ColorIndex = BLACKLIN
      On Error GoTo 0
        .Weight = xlThin
        .LineStyle = xlContinuous
    End With
  Next s

Your basic For/Next loop.

I didn't identify which line is which on the graph, but you can more or less tell by where each one ends. Anyway, the point of the graph is just to show there is substantial revision in the Household Debt Service data. The first line, high on the graph, is the November 9, 1999 vintage. I made that one red. Also red, low on the graph, is the most recent vintage: September 25, 2019. Getting late in the year, isn't it. November already.

Also red: The last vintage before the big change: June 19, 2003; and the first vintage after that change: October 22, 2003. Notes related to that revision appear in the PDF "Recent Changes to a Measure of U.S. Household Debt Service" by Karen Dynan, Kathleen Johnson, and Karen Pence.

Here's the graph as FRED shows it:

Graph #1

Here's what the ALFRED data gave me:

Graph #2

You can click the second graph for an enlarged view.