Sunday, November 29, 2020

Not "interest only"

My concern with the growth of finance as a cause of slow economic growth goes back to the cost-push inflation of the 1970s. That inflation was often attributed to rising wages or the rising price of oil. But I think it had its roots in the rising cost of finance, roots that go back further, at least to the 1950s.

A continuing-cost problem will result in either slowing growth or cost-push inflation, or some combination of the two, depending on the level of "accommodation" provided by economic policy. If they print money you get inflation. If they don't, you get slowing growth.

Many people say inflation is always demand-pull and never cost-push. They say inflation is always caused by printing money. They say the inflation of the 1970s was caused by accommodative policy, which dealt with rising cost by increasing the quantity of money. I say that when the accommodative policy is a response to rising cost that would otherwise have caused unacceptably slow growth, the inflation is caused by the cost-push pressure.

I agree with the demand-pull view to this extent: We cannot have inflation unless the quantity of money increases enough to support spending at the higher price level. However, the focus of that view is only on inflation, as if the pressure of rising cost has no impact on economic growth. In these days of persistently slow growth, that view is painfully incomplete.

I don't imagine that I'm the first person ever to identify rising financial cost as the source of the cost pressure that forces us to choose between inflation and slowing growth. So I went looking for studies and statements where other people have expressed a view like mine. I came upon The Interest Cost-Push Controversy (PDF, 8 pages) by Thomas M. Humphrey. It sounded promising.

Humphrey's paper describes a controversy between Thomas Tooke and Knut Wicksell regarding the cause of inflation. Tooke said high interest rates add more to the cost of output than do low interest rates, so high interest rates are inflationary. In response, Wicksell developed a whole theory. Today, Wicksell's thinking is embedded in our thinking. When I said above that we cannot have inflation unless the quantity of money increases enough to support spending at the higher price level, that's Wicksell. I didn't know.

Humphrey writes:

The Tooke-Wicksell controversy is important not only because it produced the first clear statement of the interest cost-push doctrine as well as the first rigorous and systematic attempt to disprove it, but also because it helped establish the case for tight money and because it introduced the prototype of the analytical macroeconomic model that most monetary authorities use today in designing anti-inflationary monetary policies.

I found the Wicksell stuff fascinating.

Thomas Tooke's argument, as presented by Humphrey at least, was disappointing. It is not about financial cost. It is only about the cost difference arising from a change in interest rates. The "so-called interest cost-push school," Humphrey writes, "... insists that higher interest rates are inherently inflationary because they raise the interest component of business costs".

Thomas Tooke, Humphrey says,

author of the monumental six volume History of Prices (1838-57), and foremost collector of price and monetary data in the 19th century, had advanced the interest cost-push argument that high interest rates cause high prices and low rates low prices.

Tooke's focus was the effect on prices of high versus low interest rates. Nothing else. Interest only. The difference in cost attributable to a change in interest rates.

Focusing solely on the cost aspects of interest and ignoring the influence on prices of interest-induced increases in borrowing, lending, the money stock, and spending, he asserted that a reduced loan rate “has no . . . tendency to raise the prices of commodities...”

The whole "interest cost-push" argument is based on the cost of interest being greater when interest rates are higher. I was looking for an argument about the cost of finance, not just the rate of interest. In this respect, the article was a disappointment.

It seems to me that Thomas Tooke considered his topic from a static microeconomic perspective, evaluating the cost of a loan at two different rates of interest. From a macroeconomic perspective, one would want to consider also whether the total number of loans increased over time, and the aggregate cost difference between the larger and smaller accumulations of debt.

If the rate of interest is constant while the accumulation of debt doubles relative to GDP, the cost of interest doubles, relative to GDP.

If the financial sector of the economy grows faster than GDP, it creates a continuing-cost problem for all other sectors of the economy. Depending on the level of accommodation by the Fed, the result is inflation, or slow growth, or both. This result will continue as long as finance continues growing faster than GDP.

And now you know how we got to where we are today.

Thursday, November 26, 2020

Shares of GDI and the Great Inflation

Allan Meltzer dates the Great Inflation as the period from 1965 to 1984:

Compensation of Employees as a percent of Gross Domestic Income:

Click the links below to highlight the graph:

1966 to 1970 may be the wage-push part of the Great Inflation. The increase suggests it.

1971 to 1985 certainly is not wage-push. The downtrend denies the possibility.

Come to think of it, 1954 to 1965 doesn't show a wage-push increase, either. Again, there is no trend of increase in employee compensation as a share of Gross Domestic Income. But something was driving prices up. In those years we find a worrisome warning of the Great Inflation to come: the creeping inflation of 1955-1958. Samuelson and Solow wrote of it in 1960:

This emphasis on demand-pull was somewhat reinforced by the Korean war run-up of prices after mid-1950. But just by the time that cost-push was becoming discredited as a theory of inflation, we ran into the rather puzzling phenomenon of the 1955-58 upward creep of prices, which seemed to take place in the last part of the period despite growing overcapacity, slack labor markets, slow real growth, and no apparent great buoyancy in overall demand.

If inflation was rising because wages were leading the way, wouldn't demand have been buoyant?

Everywhere you look, people say cost-push inflation was due to the rising cost of oil or the rising cost of labor. But that's in recent decades. In the 1950s and '60s, before oil became a problem, everybody blamed the cost of labor. The bleedin' obvious, Basil Fawlty would say.

Obvious, yes, but not the right answer.

The growing cost of finance in the 1950s was the spark that was to create the raging fire we call the Great Inflation. 

But these days, not so much the inflation. These days, finance hinders growth instead, because the Fed is less willing to "accommodate" the cost pressure. And again, let me add that because the cost of finance creates continuing cost pressure throughout the economy, the "hindering" of economic growth has become long-term economic decline.

Tuesday, November 24, 2020

A picture is worth a thousand words

Graph #1: Profit as Percent of Gross Value Added, for Financial Corporate Business (red)
Profit as Percent of Gross Value Added, for Nonfinancial Corporate Business (blue)

Monday, November 23, 2020

Are you ready for the end of the Brexit transition?


Found this site while looking for stagflation data for 1965...


Been up for a while now, apparently. I didn't know they were doing anything. 

They made a web page.

A few highlights:


But why are they calling it the "end" of the transition, now that they're ready to start? It seems to me like a subtle admission it's doomed to fail.

Sunday, November 22, 2020

They think like bankers, that's the problem

I focus on cost, the cost of credit versus the cost of money. If you want to use credit, you're gonna have to pay interest on the money you borrow. If you want to use money, you may have to work to get it, but once you have it, you have it and you don't have to pay interest on it.

I distinguish credit from money by whether or not you have to pay interest on it. Some people reject this idea, but there is no thought more important in our economy: Credit is money we have borrowed.

And what is debt? Debt is the money we pay interest on. Debt is the amount of money we have borrowed and not yet repaid. Debt is the measure of credit in use.

Suppose the interest rate is 3%.

Suppose credit-in-use in the US is about 3¾ times the size of the quantity of money. That means, for every dollar of money, we're paying about 11 cents in interest charges. This was the situation in 1946.

Suppose credit in use in the US is about 38 times the size of the quantity of money. At an interest rate of 3%, for every dollar of money, we're paying about $1.14 in interest charges. This was the situation in 2007 (except the interest rate was like 5% in 2007).

The average cost of interest per dollar in 1946 was 11 cents. The average cost of interest per dollar in 2007 was more than a dollar more than 11 cents. (And that's assuming an interest rate of 3%.)

That's why I distinguish between money and credit: So I can see this cost.

If you say "this is the result of economic policy" then I say yes, you are absolutely right. But I will also say policymakers have it wrong. I don't think they look at "the average cost of interest per dollar of money" at all. How else could they let interest cost increase so much? How else could they fail to notice that the high cost of interest is a problem?

They think like bankers, that's how. For them, more borrowing means more business. That kind of thinking creates problems for the economy.

Policymakers think using credit is good for economic growth. It is. But debt's a killer. Using credit creates debt, and the debt's a killer.

By the way, using money does not create debt. But you knew that.

Policymakers think using credit is good for economic growth. So they create policies that make it easier for us to use credit. Okay, but using credit creates debt. Our debt increases because of their policies. And policymakers don't create policies to help us reduce our debt. 

Take the tax deduction for mortgage interest, for example. You don't pay tax on the interest you pay. This is to encourage people to get mortgages. And wouldn't you know it, when the financial crisis arose, 2007-2008, mortgage debt was the big part of the problem.

We should scrap the tax deduction for mortgage interest, and replace it with a different policy that creates an equivalent tax break for homeowners. Instead of getting a tax break for paying interest, we should be getting a tax break for making extra payments on the mortgage. Instead of getting a tax break for having a mortgage, you'd be getting a tax break for paying it off early.

When you take out a loan, you get the money along with an obligation to pay it back, with interest. That's what credit is: money, plus the obligation to pay it back. 

If I borrow a dollar and spend it, I'm spending credit. But only the "money" part of the credit changes hands. The obligation to pay it back stays with me. The "debt" part of credit stays with the borrower. The "money" part of credit is the part that changes hands when we spend it. And the person who receives it receives money, not credit, because she didn't borrow it. I did. (Read that again.)

There is a problem with paying debt back early. If policymakers change the tax deduction so it encourages us to pay off our debt early, by making those payments we will be reducing the quantity of money in the economy. This undermines the whole concept of using credit: Using credit doesn't help the economy grow if we pay back the money too soon. When we pay it back, it's not in the economy anymore, being spent. That's the problem with paying debt back early.

There is a simple solution. Let the Fed keep an eye on the "average cost of interest per dollar". Let them increase the quantity of money -- that's money, not credit -- in the economy, increase it enough to offset the effect of us paying back our debt early. One way to do it? Let our paychecks grow a little faster. It's not rocket science.

By the way, the money I'm talking about is the money that changes hands. M1 money. That's the money we receive as income, the money we spend, the money that's "readily accessible for spending".

But maybe you don't like the idea of letting our paychecks grow a little faster. I admire your altruism. And you are right: We have to prevent the inflation that might be induced by rising pay. No problem.

Instead of suppressing the increase of money, policy should be suppressing the increase of credit. We went over this already. Tax breaks for home mortgages have to change. Tax breaks for business use of credit have to change. The "bankers' mindset" of policymakers has to change: Stop encouraging the growth of finance!

If we do it right, the increased growth of money is offset by decreased growth of credit-use, so our improving paychecks create no inflationary pressure. At the same time, the increase of money and the decrease of credit-use reduces the average cost of interest per dollar. It reduces the cost of finance. It relieves the cost pressure created by the rising cost of finance.

And you know what? Relieving the cost pressure created by finance improves living standards, lifts profits and improves economic growth.

Let us begin.

Sunday, November 15, 2020

The "Continuing Cost Pressure" Theory of Stagflation

From Investopedia, Inflation vs. Stagflation: What's the difference? by Tony Daltorio:

There are two main theories about what causes stagflation. One theory states that this economic phenomenon is caused when a sudden increase in the cost of oil reduces an economy's productive capacity. Because transportation costs rise, producing products and getting them to shelves gets more expensive, and prices rise even as people get laid off.

Another theory posits that inflation is simply the result of poorly conceived economic policy. Simply allowing inflation to go rampant, and then suddenly snapping the reins, is one example of a poor policy that some have argued can contribute to stagflation. Others point to the harsh regulation of markets, goods, and labor combined with allowing central banks to print unlimited amounts of money.

Oddly, Simplicable offers the same two theories:

Stagflation is caused by shocks to an economy such as a sudden price increase in energy. It can also be caused by economic mismanagement such as an overly aggressive expansion of money supply.
Good grief! So does Wikipedia. And Proshare. The same two theories.

The one theory says a supply shock (like "a sudden increase in the cost of oil") can lead to higher manufacturing and distribution costs, and to higher prices which reduce demand and slow the economy. The other theory says bad policy is the cause.

It seems to me that stagflation could arise either way. Surely there is more than one way it might happen. And yet, neither theory is completely satisfactory. The theory of bad policy is not specific. The "supply shock" theory is too specific: A sudden increase in the cost of oil is not the only thing that can create a negative supply shock. Given the right circumstances, any rising cost could lead to stagflation. It wouldn't even have to be sudden.

What circumstances? The rising cost would have to create long-term, continuing cost pressure, pressure that even if resolved today returns tomorrow. Not one or two oil shocks fifty years ago, but something that happens repeatedly or continuously.

People who say "there's no such thing as cost-push inflation" often point out that if not for monetary "accommodation" by the central bank, cost-push pressure would only create a change in "relative" prices: If the price of oil went up, other prices would go down until balance was restored. I can see that. But if it's a repeating or continuing cost increase, it's a different ball game.

If the cost of oil doubled every year, for example, all other prices would soon "relative" themselves down to zero. In that situation, I don't think even monetary accommodation could help. If it was only a 20% increase each year we'd last longer, but still the cost of oil would kill off our civilization, probably before we found some other way to do ourselves in.

What would be the properties of a cost that creates long-term, continuing cost pressure?

  • It could be a slow-growing cost, not necessarily a sudden shock like oil in the 1970s.
  • It would have to be a massive cost, massive enough to impact our massive economy. And
  • It might be a cost we don't see as a problem: continuing cost growth that, for some reason, doesn't much concern us.

The only cost I know that has these properties is the cost of finance.


Surely there are more than two ways stagflation could arise. Allow me to offer a third theory of the cause of stagflation: Continuing Cost Pressure.

Rising cost squeezes profit. Producers increase prices to restore profit. To the extent that the monetary authority "accommodates" higher prices by increasing the quantity of money, the result is inflation. To the extent that the monetary authority refuses to accommodate higher prices, the result is slowing growth. Producers are left to cope with their reduced profit as best they can, but low profit is an impediment to growth, and unprofitable business is unsustainable.

If the cost was a temporary, one-time shock to the economic system, this wouldn't be a new theory. But if the cost creates repeating or continuing long-term cost pressure, the story is entirely new. For as long as this cost pressure continues, the relative adjustment of prices can never come to an end. And all the while, the price trend is always "up" for the pressurized cost, and always "down" for everything else.

Again, I am describing the cost of finance.


Why is it that finance creates continuing cost pressure? Surely it's not because of the rate of interest. That rate goes up sometimes, and down sometimes. And lately it has spent a lot of time at "the lower bound". Surely the problem is not the rate of interest.

That's correct. The problem is not the rate of interest. The problem is the cost of interest. Five percent interest is a rate, not a cost in dollars. If you pay five percent interest, you pay five cents for every dollar you owe. It isn't a lot because it's five percent. It's a lot because we owe so many dollars. Dunno how that gets overlooked all the time, but it does -- except when we're talking government debt.

The problem is the cost of interest, and all the other fees and charges that go along with it. And the debt, the principal that must be repaid, that's part of the cost problem, too. And the cost always increases, because debt is always growing. Finance is always growing. And finance is always growing, because policymakers think that's good for the economy.


People sometimes figure the size of finance by considering employment in finance as a share of total employment. I can see that. Those people actually are working, same as the people who don't work in finance. They receive income, and the cost of it adds something to the price of output.

But all those people who work in finance only add up to around seven or eight or nine percent of the workforce. If you count just interest paid in the US, it came to 9% of GDP back in 1962. It was 31% of GDP during the 1982 recession, 32% before the 1991 recession, 27.9% before the 2001 recession, and 31% again in 2007, shortly before the "Great" recession. The average cost, for the years 1980 thru 2009, was 26% percent of GDP.

It is true that all the money that's interest cost to us is interest income to somebody. But we still have to pay it, you know? It's still a cost. We don't get to use that money to buy other stuff. And the people who receive that interest as income, they're not likely to spend it. I know, because aggregate demand is down. They put most of the interest with the money they earn interest on, and earn more interest. 

And the money in finance doesn't come back into the economy unless we borrow it, which increases the number of dollars we owe and pay interest on. Or unless the saver spends, of course, but that's anathema to the saver.

Then too, they don't get their interest income in exchange for work. They didn't make something and get paid for it. They just made money. So income increased, and output didn't. People were paid, like, output plus finance, to produce output. So the purchase price of output is the cost of output plus the cost of finance. And every time the size of finance gains on the size of GDP, the purchase price of GDP increases again. Just by growing, finance exerts continuing upward pressure on prices.


Employment in finance adds to the cost of output, pushing prices up. Interest paid reduces profit and subtracts from aggregate demand, slowing economic growth. The cost of finance contributes to both sides of stagflation: to rising prices and to slowing growth.

If the cost of finance was a one-shot cost, like an oil crisis, maybe we wouldn't even notice a problem. But finance as a rule grows faster than GDP, so it creates continuing cost pressure.


Finance grows faster than GDP. Therefore, financial cost grows faster than GDP. It's like a slow-moving version of an oil crisis where our use of oil increases every day. Even without an embargo, the cost of it eventually becomes a killer. Oh, and the credit crisis of 2007-08 was the embargo.

Back at the end of World War Two, finance wasn't yet big. Not by today's standard. People had little debt, and interest rates were low. Our lovely little finance, back then, had a lovely little financial cost that didn't much interfere with economic growth. Benefit outweighed cost. And finance, I'll venture, actually helped the economy grow.

But as we enjoyed the fruits of finance, finance grew. And financial cost grew. And there came a moment when the benefit of finance and the cost of finance were equal. That moment, I'll venture, was the end of the golden age. And finance continued to grow.

Back in the 1970s, we were already in the habit of using credit and accumulating debt. Back in the 1960s, policymakers discovered that the benefits of finance far outweighed the cost. They have busied themselves ever since, putting policies in place to expand the availability and use of credit, policies that encourage the growth of finance. And finance continued to grow.

Since the end of the golden age, for the economy as a whole, finance has been a losing proposition. At first, only a little. It was hard to see, because for a long time we thought finance was always good for the economy. But finance continued to grow.

Having grown faster than the economy for generations, finance became massive enough to influence our massive economy. And because of its massive size, the cost of finance came to outweigh the benefit. Finance started to harm to the economy. And still, finance continued to grow.

We still need finance. God knows, we need it. Somehow, we need finance more now than we did when it was little. And yes, that's part of the harm done by finance.

And finance continues to grow.

Saturday, November 14, 2020

Two brief quotes before tomorrow's post


From Randal K. Quarles, Vice Chair for Supervision, Board of Governors of the Federal Reserve System, October 18, 2018:

Traditionally, as taught in Econ 101, inflation provides a signal on whether the economy is operating above or below its potential level. If inflation moves up in a sustained manner, not just because of temporary shocks, then the economy is likely operating above its productive capacity, as firms have the leeway to raise prices given the strength of demand. Likewise, if inflation moves down persistently, then the economy is likely operating with some slack, as firms restrain prices to sell their products in the face of weak demand.


From Scott Sumner, Ralph G. Hawtrey Chair of Monetary Policy at the Mercatus Center, November 12, 2018:

So, as you may know, the Fed does inflation targeting at about two percent, but it's really more complicated than that because there's different kinds of inflation. There's supply side inflation, which is created by shocks like sudden increases in oil prices, and then demand side inflation caused by overspending in the economy. It's really demand side inflation that the Fed is concerned about. There's not much they can do about supply side inflation.


Quarles distinguishes between temporary and sustained inflation, notes that economic shocks are ordinarily temporary, and points out that sustained inflation is likely due to something other than a shock.

Sumner distinguishes between supply side inflation (created by shocks) and demand side inflation (caused by overspending). He points out that the Fed's money management only works on demand side inflation.

Tomorrow, I identify supply side inflation that is caused by a permanent shock, not a temporary one, though "shock" is not really the right word to describe it.

"Inflation" isn't a good word to use, either. When we focus on inflation, we're assuming inflation is the problem. But inflation really isn't the problem.

In addition to overspending and sudden, temporary cost shocks, I identify subtle but relentless cost pressure as a cause of inflation. This pressure is a problem which can result in a "sustained" inflation.

The overspending that Sumner mentions has only one likely outcome, inflation, because "the economy is likely operating above its productive capacity" as Quarles says.

But a supply-side cost shock has two possible types of outcome. One is inflation, resulting from overspending if the Fed allows it. The other is a slowing of economic growth as rising costs eat into profit, if the Fed refuses to permit overspending and inflation.

Like a temporary cost shock, continuing cost pressure may result in either inflation or the slowing of economic growth, depending on the Fed's response.

But a key point is often missed by people who focus on inflation: If continuing cost pressure is the problem, and the Fed doesn't allow a continuing inflation adequate to relieve the pressure, then the result will be a continuing slowdown of economic growth.

Suppressing inflation solves the inflation problem, but it doesn't solve the problem of continuing cost pressure. We must solve the problem of continuing cost pressure, so that we can prevent both inflation and long-term decline.

Friday, November 13, 2020

The 1946-48 inflation

 In Hazlitt '57 I said

Samuelson and Solow in 1960 found that inflation troubling: They describe "the rather puzzling phenomenon of the 1955-58 upward creep of prices". I keep bringing this up to emphasize that the cost-push problem goes back at least to the 1950s.

 I want to go back now and quote the whole first paragraph from S&S 1960:

Just as generals are said to be always fighting the wrong war, economists have been accused of fighting the wrong inflation. Thus, at the time of the 1946-48 rise in American prices, much attention was focused on the successive rounds of wage increases resulting from collective bargaining. Yet probably most economists are now agreed that this first postwar rise in prices was primarily attributable to the pull of demand that resulted from wartime accumulations of liquid assets and deferred needs.

I think that's right. After the war a lot of people had some money saved up, and were in the mood to spend. So, demand-pull rather than cost-push.

Recently, I found a little more about the late-1940s inflation. From The Monetary Hawks by Michael McCarthy, at Jacobin:

After wage and price controls were lifted in the wake of World War II, inflation jumped up from 8.5 percent in 1946 to 14 percent in 1947. At the time, many in Congress argued that a key cause was the spread of industry-wide union contracts that included wage increases.

McCarthy doesn't argue that those congressmen were right. But he does fill in a blank for me, better than Samuelson and Solow do with the words "much attention".

 Couple days after I wrote the above, I found a graph I did in 2017. This graph:

Graph #1: Quarterly Data Suggesting Times of Stagflation. Early 1970s rung up.

At the time I was looking for stagflation before the oil crisis of 1973. But when I found the graph just now I noticed the blue indicators of stagflation in the 1955-58 period that Samuelson and Solow thought might have been a time of cost-push inflation, and one around 1952. And right at the start of the graph, for what looks like two or three quarters of 1947, the combination of inflation and slow growth. 

So there is some justification for the "wrong war" view Samuelson and Solow observe in the 1946-48 period.

The graph is crude at best. But being as how I found it, I figured I'd add it to this post in case I look to this post at some future date for stagflation in the 1940s. Also this graph,

Graph #2: Annual Data Suggesting Times of Stagflation

which indicates stagflation in the 1890-1920 period, and then not again until after the Second World War. 

I had to look: Thomas Philippon's graph shows finance high and rising from 1890 to 1920. From 1920 to 1945 about, where no stagflation is indicated here, Philippon shows increase to about 1932, then decrease to the end of the war. And since the mid-1940s Philippon shows increase again, and my graph has indications of irregular but recurring stagflation.

And then, there's this:

If you zoom in to see it (at the Ngram viewer) there is a little activity beginning around 1860. But for the most part, nothing until the late 1940s. Then quite a lot, soon after. With red peaks in 1961 and 1973, before Volcker.

Little concern about cost-push these days. People say there is no cost-push problem.

What do they know.

Wednesday, November 11, 2020

A Better Ending for Samuelson and Solow (1960)

 From mine of 12 November 2017. Text & graphs updated.


In 1960, looking back on the latter 1950s, Samuelson and Solow wrote:

... just by the time that cost-push was becoming discredited as a theory of inflation, we ran into the rather puzzling phenomenon of the 1955-58 upward creep of prices, which seemed to take place in the last part of the period despite growing overcapacity, slack labor markets, slow real growth, and no apparent great buoyancy in over-all demand.

In the end, Samuelson and Solow could not reject the cost-push explanation:

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 ...

Ten years later, Federal Reserve Chairman Arthur Burns was pointing to the increases in employee compensation as the driver of inflation. Robert Hetzel quotes from the Board of Governors Minutes for November 1970, that Burns thought in terms of "cost-push inflation generated by union demands."

Perhaps by 1970 union demands were driving inflation. But in the latter 1950s? In the latter 1950s it was finance, the rising cost of finance that was squeezing profits.

Growing financial cost got the inflation ball rolling. Union demands took the hit for it later, and perhaps rightly so. But union demands did not create the initial problem. The rising cost of finance got inflation started and kept it going until a wage-price spiral emerged.

For domestic corporate business, the cost of interest increased faster than did compensation of employees:

Graph #1: Interest Costs Increased Faster than Employee Compensation

Consider the 1955-1958 period, the years that concerned Samuelson and Solow. For every dollar corporations paid out as employee compensation in 1955, they paid out five cents for interest costs. By 1958 that number was seven cents. For every dollar of employee compensation they paid out, corporate business spent two cents more on interest in 1958 than in 1955. Financial costs gained on labor costs.

Financial costs also gained on profits:

Graph #2: Interest Costs Increased Faster than Corporate Profits

For domestic corporate business, financial costs increased faster than profits. Between 1955 and 1958, corporate interest costs rose from 14.9 cents to 26.8 cents per dollar of corporate profits: a 12-cent increase in interest costs, 12 cents for every dollar of profit.

If financial costs had grown more slowly, if they had grown at the same rate as profits, say, how would things have been different?

In 1955, interest paid by corporate business came to $7.3 billion, something less that 15% of profits. In 1958, interest paid came to $11.4 billion, almost 27% of profits. Other things unchanged, if interest paid in 1958 remained at the 1955 percentage, the cost of interest would have been $6.4 billion. That's $5 billion less than the actual 1958 cost of interest.

If this $5 billion expenditure had not happened, other things unchanged, corporate profits would have been $5 billion higher.

But I can't add that $5 billion to corporate profit, because it changes my interest-to-profit ratio. It changes the result of my calculation, and I don't know how to proceed. In order to work thru the calculation cleanly, I cannot add the $5 billion of interest savings to corporate profits, nor to any corporate spending category. The only way to dispose of the $5 billion is to reduce gross corporate revenue by reducing the price of corporate output.

In 1958, the gross value added (GVA) to the economy by corporate business amounted to $256.9 billion. If we reduce the price of GVA by $5 billion, the reduced number is $251.9 billion. The reduced GVA number is 98% of the original number. So, to make the calculation work we have to reduce the price of corporate output by 2%.

If corporate interest costs in 1958 remained in the same proportions as 1955, corporations could have reduced their prices by 2% without reducing their profits and without reducing the wages and benefits paid to their employees. Without reducing any of their spending, other than interest.

This is an exercise in "other things unchanged". Ceteris paribus. The assumption is not realistic. But the numbers tell an honest tale: The cost of interest increased faster than other corporate business costs, fast enough to push prices up 2% between 1955 and 1958.

This suggests a different conclusion for the Samuelson-Solow paper. It suggests financial-cost-push as the cause of the 1955-1958 inflation.

Tuesday, November 10, 2020

The Great Election Theft of 2020 (revised)

I know President Trump says the Democrats stole the election. And Biden did beat Trump in the race for President. But none of the other polling predictions worked out for the Democrats. So it doesn't make sense to say that the Dems stole the election. 

It makes more sense to say the Republicans stole the election. It's the Republicans that created all those fake ballots. That's why the state and local results defy the polling predictions. And that's why it looks like voter turnout was so high.

And the Biden win? 

The Republican thieves didn't make enough fake ballots. They underestimated the hate people have for President Trump. In the race for President, the honest ballots won.

The evidence? It's a tried and true Republican tactic: Point the finger first. Do the dirty deed and be quick to claim it's the other guy doing it.

Monday, November 9, 2020

Edward Sonnino

I googled paul volcker on cost-push inflation. First three results:

1. Paul Volcker took dramatic steps to reign in inflation.

2. Arthur Burns broke it; Paul Volcker fixed it.

3. It's not true that Volcker whipped inflation! by Edward Sonnino.

Wait! What?? 

An excerpt from Sonnino:

The logic behind the belief that Volcker’s extremely tight money brought down the high inflation of the early 1980’s rests on the flawed assumption that there is only one strain of inflation, “demand-pull inflation”. But there is a second, distinct variety of inflation, i.e., “cost-push inflation”, having completely different causes and requiring completely different economic policy responses. “Demand-pull” inflation, the most common variety of inflation, is due to excess aggregate demand, the situation of “too much money chasing too few goods”, corresponding to a booming economy with high capacity utilization and low unemployment. “Cost-push” inflation, a historically rare variety of inflation, is instead due to increased costs of production and distribution having nothing to do with excess aggregate demand. Those increased costs are transmitted by companies to consumer prices in an attempt to protect shrinking profit margins, even when such price increases result in fewer sales.

That's the second paragraph, and it is exactly right. Exactly right, except cost-push inflation is more common than Edward Sonnino says, and demand-pull (with its "booming economy with high capacity utilization and low unemployment") is less common.


See also the Anna Schwartz quote in mine of 31 October 2009

And by the way, the CPI for October 2009 was 216.509. For September 2020, 260.209. That's a 20% increase in the price level.

Sunday, November 8, 2020

Hazlitt 1957: Not "only"

At Mises: Cost-Push Inflation? by Henry Hazlitt, from Newsweek July 22, 1957.

His topic: "Expansion of the money supply is both the necessary and the sufficient cause of inflation."

My favorite part: "Anticipations":

The Conference Board tries to prove that the increase in the money supply cannot be the cause of the price rise in the last two years, because the money supply has not gone up in this period. But this overlooks longer comparisons and mistakenly assumes that changes in money supply must reflect themselves exactly proportionately in prices with neither time lag nor anticipations.

Expansion of the quantity of money is the cause of inflation, Hazlitt says, even if that expansion is only anticipated. The increase in the quantity of money is still responsible for the inflation, he says, even if the money didn't increase.

Maybe he's saying that if the quantity of money increases after the prices go up, then prices don't have to come back down again, and the increased money is therefore ultimately responsible for the inflation. I might agree with that, if he said it that way, but he didn't. 

My read of what he said is that the increased money is the cause of the inflation. Clearly, he disputes the Conference Board view that "increase in the money supply cannot be the cause" of the inflation. Hazlitt thinks it *is* the cause -- "the necessary and the sufficient cause". 

But, the only cause? This, Hazlitt does not say. Yet the idea that there is no other cause of inflation is an unstated premise of his argument. Without that premise, his cause-of-inflation argument falls apart.


Hazlitt doesn't talk about why prices were trying to go up. Maybe they weren't. But maybe there was an unobserved upward cost pressure squeezing profit and putting upward pressure on prices. And if there was such cost-push pressure, the failure of the Federal Reserve to accommodate would cause economic growth to slow and unemployment to increase. Hazlitt is aware of this:

Expansion of the money supply is both the necessary and the sufficient cause of inflation. Without such expansion, an excessive increase in wage rates would lead merely to unemployment.

What he doesn't say is that any persistent cost increase -- not just wage rates -- can lead "merely" to unemployment and slow growth. The rising cost of oil in the 1970s is often held up as an example. The rising cost of finance is never held up as an example.

If the cost pressure exists, then it is the source of downward pressure on economic growth, which the Fed would want to fight by increasing the quantity of money. This Fed action will convert the cost pressure from downward pressure on growth to upward pressure on prices, and result in inflation. But you leave out a lot, including the driving force (the cost pressure) if you reduce this analysis to "Expansion of the money supply is both the necessary and the sufficient cause of inflation."

The increase in money is necessary and sufficient but it is not the only cause of inflation. Oh, and an inexplicable long-term slowing of economic growth is evidence that cost-push pressure exists.

The trouble with Hazlitt's view is that it brings evaluation of the cost problem to a halt. It tells us we don't have to look for the cost pressure that may be the real, underlying cause of inflation. It tells us not to bother looking. 

And almost no one bothers to look.

My other favorite part is where Hazlitt quotes from a study by the Conference Board: 

Since prices have continued to rise, the clear lesson of 1956 is that money and its rate of use are not the sole determinants of price.

Two reasons I like it. First, they're talking 1956. Samuelson and Solow in 1960 found that inflation troubling: They describe "the rather puzzling phenomenon of the 1955-58 upward creep of prices". I keep bringing this up to emphasize that the cost-push problem goes back at least to the 1950s.

The second reason, far more important, is that "money and its rate of use are not the sole determinants of price." This should be obvious. If you find a less expensive way to make your product, you may decide to reduce the price you charge for it. Or, going the other way, oil in the 1970s. Such cost pressures do not exist only in the imagination.

Hazlitt, however, completely ignores the point that money and its rate of use are not the sole determinants of price. That's funny, you know, because Volcker did not address that point either when, as head of the Fed, he severely restricted the quantity of money to fight inflation, and expressed no concern that the cost pressures might find some other outlet for their release.

Friday, November 6, 2020

Heavy debt burdens (already in 1975)

Excerpted from Capitalism and irony

The textbook I used when I took Econ 101 (McConnell Economics, 1975) says

Although the size and growth of public debt are looked upon with awe and alarm, private debt has grown much faster. Private and public debt were of about equal size in 1947. But private debt has grown much faster and is now over three times as large -- about $1,350 billion, compared with $470 billion -- as the public debt.
And that's from the 1975 edition. McConnell adds:
If you insist upon worrying about debt, you will do well to concern yourself with private rather than public indebtedness.


McConnell's debt numbers may seem laughable now. Nobody was laughing in 1975.

Finance is bigger than you think.

Tuesday, November 3, 2020

Finance is bigger than you think

FRED offers "corporate" data and "corporate business" data. The two categories are not the same. Today we look only at corporate business data.

FRED's corporate business data is divided in two parts: Financial Corporate Business (FCB), and Nonfinancial Corporate Business (NCB). Together, the two make up corporate business.

FRED offers data on the profits and assets of corporate business, such as

Other components like "Financial corporate business profits" and "Nonfinancial corporate business; Total Nonfinancial Assets" can be calculated from the given components.

Oh, by the way: "Nonfinancial" business activity makes and services things. "Financial" business activity makes and services money.

Nonfinancial corporate business profit as a percent of Total corporate business profit:

Graph #1: NCB Share of CB Profit, showing Gradual Decline

During the seven decades shown, the profit of Nonfinancial corporate business declined from above 90% to about 75% of Total (Financial plus Nonfinancial) corporate business profit. We can subtract those numbers from 100% and figure that the profit of Financial corporate business increased from 10% to 25% during that same period.

The split was 90/10 in the early years. It has been 75/25 in recent years. This change is something of a concern, because profit share has fallen for Nonfinancial business, the businesses that make and service the things we buy. 

Yet perhaps it is not much of a concern, as Nonfinancial corporate business profit remains much larger than Financial corporate business profit. It doesn't seem that the relatively small decline in the profit of Nonfinancial business could bear much of the blame for the relatively large economic problems in this new millennium of ours. 

But no.

I have to take another look at Nonfinancial corporate business.

There has been only a small change in the Nonfinancial share of Corporate business profits. Funny thing, though: There has been a large change in the assets of Nonfinancial corporate business:

Graph #2: Financial Share of NCB Assets, showing Massive Increase

The Financial assets of Nonfinancial corporate business rose from about 22% of Total NCB assets in the 1950s, to 45% or more by the late 1990s. The Financial assets of Nonfinancial corporate business doubled as a share of Total NCB assets.

Now, it seems to me that the profit arising from Nonfinancial assets is Nonfinancial profit, and the profit arising from Financial assets is Financial profit. So Graph #2 suggests that since the year 2000, almost half the profit of Nonfinancial corporate business has been Financial profit. But this Financial profit has been counted as part of Nonfinancial corporate business profit.

The discrepancy, or what I see as a discrepancy, arises because profit (as shown in Graph #1) is figured for the nonfinancial business type, while the profit I expect to see is nonfinancial profit arising from nonfinancial economic activity -- from making and servicing things rather than money.

Nonfinancial businesses apparently engage in a lot of Financial activity. I suppose that's the smart thing to do in an economy that exhibits an extremely high reliance on credit, as ours does. But if our excessive reliance on credit creates problems, and if we are troubled by the drift of Nonfinancial business into Financial activity (because it suggests problems in the Nonfinancial sector) then our best options are to reduce our reliance on credit through changes to policy, and to shift our Financial/Nonfinancial profit focus from categorization by business type, to categorization by the type of economic activity that actually generated the profit. Profit from nonfinancial activity is nonfinancial profit, and profit from financial activity is financial profit, no matter what type of business makes the profit. Or so it seems to me.

We might want to take the profit of Nonfinancial corporate business, and figure the part that actually arises from Nonfinancial activity and the part that is attributable to Financial activity. It seems reasonable too, to me, to count the profit arising from the Nonfinancial activity as Nonfinancial profit, but to count the profit arising from the Financial activity of Nonfinancial business (along with the profit of Financial business) as Financial profit. 

Again, we should be categorizing profit by type of profit rather than by type of business. Is that really beyond the pale?

Using the data from Graph #2, we can create a share-of-assets ratio that indicates the percentage of Nonfinancial corporate business profit that arises from Nonfinancial activity.

We can then take the Nonfinancial share of Corporate Business profit from Graph #1, multiply it by our "share of assets" ratio, and find the percentage of total Corporate business profit that arises from the Nonfinancial activity of Nonfinancial corporate business. This is shown on Graph #3:

Graph #3: Nonfinancial Profit of NCB as a percent of Corporate Business profit

The Nonfinancial profit of Nonfinancial corporate business fell from 70% of total corporate business profit in the early 1950s, to 40% now. If Nonfinancial profit is 40% of Corporate business profit, then Financial profit is 60%: more than half of Corporate business profit.

Profit figured by type of business (Graph #1) shows the Nonfinancial share down to 75% of Corporate business profit. Profit figured by type of profit (Graph #3) shows the Nonfinancial share down to 40%. Financial profit is not 25% of Corporate business profit, but 60% -- half again as much as the Nonfinancial share, and more than twice what we thought.

Nonfinancial profit is no longer bigger than Financial profit. It is significantly smaller. And while the decline of "Nonfinancial corporate business profit" may have been relatively small, "Nonfinancial profit" has suffered an uncomfortably large decline -- and "Financial profit" an uncomfortably large increase. 

The increase in Financial profit (which outside of the Financial sector is cost, not profit) together with the decline of Nonfinancial profit could bear much of the responsibility for economic problems in this new millennium of ours. No one should think this is "not much of a concern". The business of producing and servicing things is in worse shape than we have been led to believe. But it is more in line with experience.

Sunday, November 1, 2020


Google Search turned up a link to this graph:

Graph #1: Interest Cost as a Percent of Employee Compensation for Domestic Corporate Business

I don't think it's one of mine. This one was at FRED. But it showed only 1947 to 1965 -- the period before the Great Inflation. Oh, so maybe it is mine. No matter. If it's yours, thanks!

The graph shows interest costs as a percentage of employee compensation, for corporate business. It's another way to see interest costs encroaching on money that might otherwise have been used to meet payroll.

As presented here, the graph shows all the years in the data set. At the start -- in 1946 -- the amount corporate business was paying out for interest was less than 4% of what they were paying as employee compensation. At the end -- in 2019 -- it was more than 20%.

19.81% in 1973, at the end of the "golden age". High points in 1982, 1989, 2000, and then 2007 when the interest cost reached 48.59% of employee compensation. Almost half. And you know what happened after 2007.