Separating the cost-push from the inflation

Mine of the 27th is about how the growth of one sector of the economy (relative to the rest of the economy) can create cost pressure that tends to cause cost-push inflation... One sector, like "government" or like my favorite target, "finance".

Mine of the 25th is part of a series about how a decline of labor productivity (caused by labor force growth) may create cost pressure that tends to cause cost-push inflation.

Both posts are about cost-push inflation arising from some source other than rising prices (like the price of labor). In neither post does the cost pressure initially arise from rising prices that must be paid.

• Sectoral growth can create pressure simply because there are more transactions -- more people paying taxes, for example, or more people borrowing money. The cost pressure can arise even without increases in tax rates or interest rates. I say this all the time about interest rates versus the amount of debt on which interest must be paid.
  
  
• Falling labor productivity creates pressure not because it increases wage rates, but because it reduces the output that labor creates. The cost is generated internally, within the business itself, and passed on from there. 

I'm tempted to say that in *no* case does the cost pressure initially arise from rising prices that must be paid. But I can't imagine that's 100% true.

 

I notice that, more and more, I am separating the "cost-push" problem from the "inflation" problem in "cost-push inflation".

The "cost-push" problem -- the cost problem -- may arise from unusual circumstances like extremely rapid increase in the Labor Force Participation Rate for a year,, say, or persistent, long-term growth of the financial sector, or perhaps from other causes.

The "inflation" problem arises when some change in "money" makes possible an increase in spending and aggregate demand, perhaps as a solution to a cost problem or to the "slow growth" problem that arises therefrom.

But we must never forget that of the two, cost and inflation, it is cost that is the greater problem. Cost reduces economic growth. Sustained cost -- which economists have defined out of existence, by the way -- is how civilizations die from suicide.

Inflation may postpone this but does not prevent it.

Starry-eyed and hopeful: Unbalanced sector growth as a source of cost pressure

Inflation & the Rise of the Government Sector: An Analytical Survey (1979) by John H. Hotson

Hotson's opening:

That the rise of the government sector in recent decades is the root cause of the inflation which has plagued these same decades is not a thought which has occurred forcefully to many economists.

Hotson's observation, reinforced by the title of his article, offers support for my running argument that cost-push inflation is driven by the growth of finance:

• Each sector of the economy is a cost to the rest of the economy.
  
  
• The growth of one sector, relative to the rest of the economy, creates cost-push pressure.
  
  
• Unless the central bank relieves the cost pressure by allowing inflation, cost pressure slows economic growth.
  
  
• Sector growth is liable to be a long-term phenomenon, so that the containment of inflation is likely to create long-term slowing of the economy, as the developed world has seen over the past 60 years.
  
  

Hotson reinforces his observation with a quote from Robert Heilbroner:

When we look at the historical picture, the root cause of the recent inflationary phenomenon suggests itself immediately. It is a change that profoundly distinguishes modern capitalism from the capitalism of the prewar era - the presence of a government sector vastly larger and far more intimately enmeshed in the process of capitalist growth than can be discovered anywhere prior to World War II ...

I would change two of Heilbroner's words to one:

... the presence of any sector vastly larger and far more intimately enmeshed in the process of capitalist growth than can be discovered anywhere prior to World War II ...

and that about sums it up.

One measure of size, commonly used as a measure of problems related to government, is the size of the debt. Here's an old graph of total debt, and five components of it, shown relative to GDP:

From my blog post of 23 January 2010
Original Graph by CONTRAHOUR at Seeking Alpha, 28 Jan 2009

 

The graph doesn't show where we are now. But it does show what happened during the time the economy went from "good" to "bad". I'll paraphrase what I said about it before: 

The topmost plotted line shows total debt. On the right-hand side of the graph, the next line down from the top is "Domestic Financial" debt.

On the right-hand side, the most recent numbers show domestic financial debt is the largest component of the debt. On the left-hand side, the graph shows domestic financial debt was the smallest component in the 1960s.

Clearly, domestic financial debt has been the fastest-growing component of our debt.

The growth of one sector, relative to the rest of the economy, creates cost-push pressure. If the sector's growth is natural, it may not be a problem. But if the growth arises from an unnatural cause such as economic policy that consistently favors the growth of finance, it could very easily be a problem, and one most difficult to solve.

Let me paraphrase Hotson's Heilbroner quote:

The graph shows the presence of a financial sector vastly larger and far more intimately enmeshed in the economy than can be discovered anywhere prior to World War II ... When we look at this historical picture, the root cause of the recent inflationary phenomenon suggests itself immediately.

These days, inflation is among the least of our economic problems. Forgive Hotson and Heilbroner their focus on inflation. Hotson was writing in 1979, Heilbroner in 1978. 

Me, I have a somewhat different concern.

Do keep in mind two things. First, economists' diagrams of inflation show that 

• Demand-pull inflation works itself out through faster economic growth
  
• Cost-push inflation works itself out through slower economic growth

Economist Frederic Mishkin explains:

[D]emand-pull inflation will be associated with periods when output is above the natural rate level, while cost-push inflation is associated with periods when output is below the  natural rate level.

The growth of finance creates cost-push inflation, not demand-pull. So we can simplify the Mishkin quote by omitting the "demand-pull" part: Mishkin says "cost-push inflation is associated with periods when output is below the natural rate level." Output "below the natural rate level" means economic growth is slow. Mishkin is saying that cost-push inflation makes the economy slow. 

The economists' diagrams tell us the same thing: cost-push inflation makes the economy slow.

I prefer to think that cost pressure makes the economy slow, and that if they let some inflation occur, the central bank relieves some of that pressure and the economy slows less. But we can go with it Mishkin's way for now, if you prefer.

Mishkin's statement makes sense if we assume cost-push inflation is temporary: We get a few years of slow growth, and then things return to normal. Economic performance returns to the natural rate level.

But if the inflation is sustained
But if the cost pressure is sustained, the economy will seem to be permanently below the old natural rate level. Economists will say the natural rate has fallen, and they will lower their estimate of the natural rate. At least, that's what happens with potential output.

The new estimate may bring the natural rate down to the actual growth level. We can, however, expect the cost pressure to continue driving actual economic growth down until it is again below the estimated natural rate. But this doesn't happen because "cost-push inflation is associated with periods when output is below the natural rate level." It happens because cost pressure reduces economic growth.

Maybe we should look at the natural rate as a best-case estimate of growth, an estimate that arises from actual economic performance. The economy doesn't grow slowly because the natural rate is low. It's the other way around: The natural rate is low because the economy is growing slowly.

Furthermore, if cost pressure has made the economy slow but the cost pressure still exists, the economy will slow more.

This is what happens when the inflation is cost-push. It continues to happen as long as the cost problem continues to exist, and it happens whether the central bank allows inflation or not. Do what you will -- abandon Keynesian theory, come up with supply-side policies to boost economic growth, deregulate finance, whatever -- the decline of growth continues regardless, until the cost problem is resolved, one way or another, for better or worse, rising again or falling to ruin.

"And on the pedestal these words appear:
'My name is Ozymandias, king of kings:
Look on my works, ye Mighty, and despair!'
Nothing beside remains..."

Scott Sumner said

I am not denying that growth in US living standards slowed after 1973, rather I am arguing that it would have slowed more had we not reformed our economy.

Yes, the economy slowed. Yes, the reforms helped. But the reforms did not solve the problem. They did not solve the cost problem. And after Paul Volcker solved the inflation problem in the early 1980s, economists quit looking for a cost problem. Instead, they defined "cost-push" out of existence.

And since the reforms did not address the underlying cause of slow growth -- the cost problem created by the continuing growth of finance --  the economy continued slowing despite being boosted by reforms. Things grew worse, and here we are today, starry-eyed and hopeful that the post-pandemic economy will grow enough to somehow justify the inflation we are now being told to expect.

And that's how cost pressure works. Inflation is not the problem we must focus on.

The second thing to keep in mind is the slowdown of economic growth. And that the solution is to reduce the size of finance, the overgrown sector that is the source of the cost pressure. We must also eliminate the policies that induce excessive growth in that sector.

There was NO initial price increase ...

If you have cost-push inflation explained as a "wage-price spiral" it is easy to picture me and my boss, each in turn, getting an increase: first my wages, then his prices, then my wages again, and so on.

But how do we know the spiral started with my wages? The chicken, or the egg?

It is easy for me to accept the "spiral of increase" as a process in motion. But how does the spiral get started? That's the stumbling block.

So okay, I have to go to the boss for a raise because the cost of living is going up. But no: We're already mid-spiral at that point. The cost of living has already gone up. The process is already in motion. The cost-push doesn't start with me. The initial "push" is unexplained.

I think this is why the "oil shock of the 1970s" is so often used as an example of cost-push inflation. Not only was it a sudden "shock" to the economic system, and a massive one, but also it is easy to picture an external force imposing a cost on our domestic economy. It is easy to see this as the initial push that starts a cost-push inflation and a wage-price spiral.

Of course, the Great Inflation of 1965-1984 began in 1965, or possibly earlier, and the first oil shock didn't begin until late in 1973. So there is a possibility that even the oil shock was not the initial push of that inflation. More than a possibility: to my mind a certainty.

And, too, you have explanations like the one George Dorgan offers:

Economists commonly explain the rising oil price between 1998 and 2008 as due to the growth of emerging markets. They classify the resulting inflation as demand-pull inflation. We argue that the cost-push inflation of the 1970s was also a reflection of rising global demand. For us, oil prices had remained too low between 1950 and 1970. They had to catch up quickly to the reality: with rising deficits and wages in the U.S. The picture only changed with the outbreak of the Yom Kippur War in October 1973.

According to Dorgan, the problem goes back to the 1950s, and the rising price of oil was due to demand-pull, not cost-push. 

So the oil shock of the 1970s may be a good example of built-in inflation and how inflation continues, but it doesn't answer the question of how cost-push inflation gets started.

I have the same problem with built-in inflation and conflict inflation and inflation driven by expectations: These explain why inflation continues, not how it gets started.

This is what makes the inflation of 1955-57 so fascinating, or at least my April 13 explanation of it: It began with an unusual year-long increase in the Labor Force Participation Rate. The supply side was "unprepared for the firehose of new workers" (to use Waldman's phrase) and the effect of the year-long increase on "the returns to experience" (to use Vollrath's) caused a fall in the growth of productivity.

The fall in the growth of productivity meant that business was getting less output per hour, and less output per dollar of wage cost. The fall in productivity growth created rising cost in the business sector.

The initial push did not happen when some guy went to his boss and demanded a raise. The initial push arose from a fall in the growth of productivity. And the fall in the growth of productivity arose from the unusual increase in labor force participation. So we can look two causes back, and still not see increasing cost as the prime mover of the 1955-57 inflation. This is not just fascinating. It is significant. It should lead economists to revise their thinking and their explanations of cost-push inflation.

There was no initial price increase that created the cost increase that started the cost-push inflation of 1955-57.

BLS employment definitions

 I want to keep this link handy!

https://www.bls.gov/cps/definitions.htm

It even includes stuff like this:

Another glance at the 1955-57 inflation

Percent Change from Year Ago, Producer and Consumer Prices  1950-1962

The increase appears to begin mid-year 1955, six months or so after the 1955 increase in the Labor Force Participation Rate began, with producer prices rising ahead of consumer prices. 

However, as the "Percent Change" view of this monthly data shows, the price rise appears to have begun in January of 1955 -- along with the unusual year-long increase in Labor Force Participation:

Percent Change, Producer and Consumer Prices  1950-1962

Exploring

I just discovered that the "current dollar output" of the business sector follows the same path as "gross value added" of "GDP: Business":

Graph #1: Current Dollar Output (yellow) centered on GVA Business

To see that they follow the same path, I indexed both series to the same date.

Here's the thing: the GVA series is given in billions of dollars. The Output series is given as indexed data, so you don't know how many billions it is. But now I can convert the Output series to billions, or just use the GVA series instead.

 

  

"Price per unit of Real GVA" as a measure of inflation

Graph #2: Comparing Unit Price of Real GVA to the GDP Deflator

To my eye they look quite similar. Let me zoom in on the 1950-1962 period:

Graph #3: Comparing Unit Price of Real GVA to the GDP Deflator, 1950-1962

This graph is for comparison to the inflation graph in mine of 13 April. Here, the "percent change from year ago" in price-per-unit (blue) runs at zero from 1954:Q4 to 1955:Q2, then rises to 3.03% by 1956:Q1. It runs high until 1957:Q2, then starts to fall. 

As noted on the 13th, this inflation was driven by the cost pressure created by falling labor productivity that was caused by the rapidly rising labor force participation rate of 1955. And maybe the graph also provides evidence that high interest rates can bring down even cost-push inflation.

High interest rates, however, do not solve the cost problem that is the proximate cause of the proximate cause of cost-push inflation -- if you get my drift. Fortunately, the rapid increase of labor force participation was only a one-year event.
 

 
I also found a "Profit per unit of real GVA" series at FRED. Taking that profit as a percent of "Price per unit of real GVA" generates this distinctive pattern:

Graph #4: Profit-per-Unit as percent of Price-per-Unit of Real GVA of NCB

The malaise of the 1970s is clearly visible after the fall from high (above 10%) profits to low (below 10%) profits in the latter 1960s. One decade of low profits was more than enough to change mainstream economic thought. Since Reagan, the highs have gone higher and, since 2000, even the laws that govern the functioning of the economy appear to have been altered by policy.

I don't know how else to describe it.

"relatively low and relatively stable"

I'm still looking for an explanation of the 1955 increase in the Labor Force Participation Rate. I figure it was caused by return to civilian life after the Korean war. But I hesitate to say it because the timing seems off, and because I should be able to find something on the internet that actually identifies the cause of that 1955 increase. However, that's not my topic just now.

Unmentionables

According to The Rise and Fall of Labor Force Participation in the U.S. at the St. Louis Fed,

If you know only one aspect of the data on labor force participation, it should be this: Labor force participation used to be relatively low, it rose during the 1970s, 1980s and 1990s, peaking in 2000, and it has generally been declining since 2000.

That's great, if you only want to know the one thing. 

Here's their next thought:

From 1948 to 1966, the labor force participation rate was relatively low and relatively stable, averaging 59.1 percent.

Low and stable. Except for a one-year increase of more than two percentage points, which shall go unmentioned. 

Unmentioned. I wonder why that is.

Here, some of my notes that didn't make it into the 13 April post:

The Labor Force Participation Rate (LFPR) shows the percentage of the working-age population that has a job or wants one. When baby-boomers reached working age, the rate went up. When women in the workforce became a thing, the rate went up. The LFPR increased from 58.6% in January 1965 to 66.8% in January 1990, or 8.2 percentage points in 25 years. A remarkable increase.

The LFPR increased from 58.1% in December 1954 to 60.2% in December 1955, or 2.1 percentage points in just one year. A remarkable rate of increase. If it had continued at that rate, it would have equaled the 1965-1990 increase in less than four years.

Not worth a mention?

Productivity

In the 1950s, cost-push inflation was sometimes attributed to low productivity.

In The Wage-Push Inflation Thesis, 1950-1957 Lowell E. Gallaway (1958) wrote:

Simply stated, the wage-push inflation thesis holds that money wage rates have increased more rapidly than physical productivity and, consequently, have exerted upward pressure on costs and prices.

 In Time magazine, 15 July 1957, we read:

General Motors set up the first automatic "annual improvement factor" increase in wage contracts in 1950

and

The upward trend of wages was due not only to the scarcity of labor but also to the spread throughout industry of the G.M. idea of automatic increases. This ran counter to traditional business practice because it placed emphasis on a long-term rise in productivity and kept wages rising even when productivity temporarily stopped rising (as it did last year) or business temporarily slackened (as in steel and autos this year).

Note that they knew in 1957 that productivity "stopped rising" in 1956. That is the productivity problem I attribute to the 1955 increase in the Labor Force Participation Rate.

Note also that a decline in productivity increases labor cost to business, just as wage hikes do. It would be a simple mistake to blame wage hikes when the problem was low or falling productivity. But you couldn't fix the problem by holding wages down, not in the 1950s, and not since the 1980s.

In the early 1960s, productivity was still sharply in focus. In 1996 the L.A. Times recalled that President Kennedy

used a tactic his economic advisor, Walter W. Heller, called “jawboning” to urge business and labor to behave responsibly. In Kennedy’s time, that meant pay increases shouldn’t exceed productivity gains--and price hikes shouldn’t exceed increases in wages.

And again:

In his [January 11] 1962 State of the Union, Kennedy declared, “Our first line of defense against inflation is the good sense and public spirit of business and labor--keeping their total increase in wages and profits in line with productivity.

Networker writes:

Kennedy, since the Inaugural Address and beyond, had been asking Americans and American business to exercise restraint to enable the United States to meet its obligations and strengthen its economy. The Steel Workers of America agreed to hold off their demands for higher wages if the Steel Companies, on their part, would not raise the price of steel. The workers kept their end of the bargain, the companies did not, ordering a price increase after a strike was averted. This dishonest and irresponsible act angered Kennedy, as is made clear in the following speech.

Then, from Kennedy's April 11 1962 speech:

... there is no justification for an increase in steel prices. The recent settlement between the industry and the union, which does not even take place until July 1st, was widely acknowledged to be noninflationary, and the whole purpose and effect of this Administration's role, which both parties understood, was to achieve an agreement which would make unnecessary any increase in prices.

In his very next sentences, again, productivity was central:

Steel output per man is rising so fast that labor costs per ton of steel can actually be expected to decline in the next 12 months. And in fact, the acting Commissioner of the Bureau of Labor Statistics informed me this morning that, and I quote, "employment costs per unit of steel output in 1961 were essentially the same as they were in 1958."

It's a good speech. Kennedy was angry. He called for "a higher sense of business responsibility for the welfare of their country".

It's not like Kennedy didn't know about productivity and cost. He knew. He was focused on it. And he tried to keep prices from rising.

It didn't work. I wonder why that is.

Another unmentionable

Why didn't it work? This wasn't the latter 1950s. The economy was not adjusting to a sudden increase in labor force participation. Nor was it the latter '60s, nor later. The big change in labor force participation due to the Baby Boom and Women In the Workforce had not yet begun. It was 1962. Productivity growth was high again. Where was the problem?

I'll go back to saying what I always say: Debt was accumulating. The cost of finance was rising. Surely, by the time interest on household debt was taking more than 5% of employee compensation, people considered it part of the cost of living. Surely, rises in our paychecks had to cover the rises in our interest payments.

Annual Household Interest Costs as a Percent of Employee Compensation
Interest Costs go above the 5% level (red) before 1960

Annual Household Interest Costs, Growing as a Percent of GDP

And with household interest cost growing faster than GDP from 1946 to 1986, wage hikes that just covered the interest cost would surely have looked like inflationary increases. Looked inflationary, and were inflationary.

People were covering their costs. It was cost-push inflation, due to the rising cost of finance. It looked like inflationary wage increases for a reason. But finance didn't get the blame. Wages did.

Come to think of it, the policies that encouraged all that borrowing didn't get the blame, either. I wonder why that is.

The implications: Greater than S+S could imagine

 

From the Tuesday post:

Writing of Samuelson and Solow's 1960 paper, James Forder said:

 The question they were addressing was that of the explanation of the inflation of the 1950s – particularly the period 1955-57 – and the implications it had for macroeconomics.

 

From Steve Waldman in comments:

I agree that one episode is not a proof of anything, but despite that, the episode in question provoked massive and in my opinion unwarranted and very destructive changes in the views of macroeconomists. I’m trying to counter those changes here.

 

From Waldman's post:

Since the 1970s, macroeconomics as a profession has behaved like some Freud-obsessed neurotic, constantly spinning yarns about how the trauma of the 1970s means this and that, “Keynes was wrong”, “NAIRU”, independent (ha!) central banks. A New Keynesian synthesis made of output gaps and inflation and no people at all, just a representative household reveling in its microfoundations. Self-serving tall tales of the Great Moderation, all of them.

Doublechecking, again

Proofreading Tuesday's post in the wee hours, I came to the end:

Far as I know, which isn't far, I admit, the cause of the 1955-57 inflation was never discovered.

 That kind of thing bothers me. I'd prefer to know. Then I remembered Steve Waldman's comment:

 We have just one big boom to look at.

"Big boom," I thought. "Little boom". I should use "little boom" in a search. So I did, at Google Search:

the "little boom" in the "Labor Force Participation Rate" in "1955"

Ten results.

 

Searching the page coincidentally turned up 10 occurrences of "1955".

Nine of them are in phone numbers. The other one was in my search text.

Hey -- that means one of the ten hits Google turned up might be worth checking.

Nope. It redirects to some place I don't want to be.

So, no news. I still don't know if the cause of the 1955-57 inflation was ever found. Except, of course, I found it now.

Would I rather have found the cause to be cost pressure caused by the growth of finance? 

That *is* what my guess would have been. On 7 April I was still looking at financial cost-push in the years before 1965. That post was withdrawn because one of my graphs was bad. But there is a big difference in financial cost as you go from 1955 to 1965. I still think the growing cost of finance was the small problem that created cost issues which look like "conflict" inflation. I still think it was growing financial cost that got the Great Inflation started.

But if the 1955-57 inflation was not caused by the cost of finance, that's probably good. It would mean that finance was not already too big in the 1950s, and that would be a useful thing to know.

Answering an old question

What caused the creeping inflation of 1955-57?

 

• LFPR = Labor Force Participation Rate
  
  
• Rising LFPR as a cause of falling productivity
  
  
  1. Dietrich Vollrath:
     

     "The late 1960s/early 1970s coincide with the flood of Baby Boomers into the labor market. Are the returns to experience much more severe than we think from Mincer regressions, and so their entry lowered productivity growth before creating a spike in the late 90s as they really reached their peak?"

  2. Steve Randy Waldman:
     

     "The crucial economic fact of the 1970s is an incredible rush into the labor force... What was stagnant in the 1970s was productivity, which puts hours worked beneath GDP in the denominator. Boomers’ headlong rush into the labor force created a strong arithmetic headwind for productivity stats."

• Falling productivity as a cause of inflation
  
  
  1. Janet Yellen:
     

     "My reading of the evidence suggests that the predominant medium-term effect of a slowdown in trend productivity growth would likely be higher inflation."

  2. Tejvan Pettinger:
     

     "If firms become less productive and allow costs to rise, this invariably leads to higher prices."

  
  
• Rising LFPR => Falling Productivity => Rising Inflation
  
  
  1. Hank M. Gracchus, Jr.:
     

     "A change occurred in the late 1960s / early 1970s, however, as labor productivity slowed. Under the then-current regime, labor income continued to grow in line with the economy, maintaining its share of total income. Because productivity was no longer rising as much as previously, though, the return on capital consistent with a constant share of total income could not deliver an adequate rate of return – a profit squeeze ensued. This drove firms to increase prices, leading to larger wage demands and cost-push inflation."

  2. Waldman's "Not a monetary phenomenon":
     

     The root cause of the high-misery-index 1970s was demographics, plain and simple... The nation faced a simple choice: employ them, and accept a lower rate of production per worker, or insist on continued productivity growth and tolerate high unemployment... The result was high inflation, and would have been under any scenario that absorbed the men, and the women, of the baby boom in so short a period of time.

• Comments at Waldman's
  
  
  1. slotowner writes: "I am concerned..."
     
     
  2. Unanimous writes: "As slotowner says, the history of a single episode is not really proof."
     
     
  3. Steve Randy Waldman writes: "slotowner — Unfortunately, stats for the civilian labor force begin in 1948. We have just one big boom to look at."
     
     
  4. And, importantly, Steve Randy Waldman writes: "Unanimous — I agree that one episode is not a proof of anything, but despite that, the episode in question provoked massive and in my opinion unwarranted and very destructive changes in the views of macroeconomists. I’m trying to counter those changes here. I think the evidence for a demographic explanation is at least as strong as any evidence of misguided policy, and that post-Volcker triumphalism may well just be the fundamental attribution error in action."
     
     

There was a short-lived but extremely rapid increase in the Labor Force Participation Rate in 1955:

Graph #1a: Labor Force Participation Rate

Graph #1b: Percent Change from Year Ago, LFPR

Graph #1c: Detail Showing the Extraordinary 1955 Increase

I do not know why this anomalous increase occurred, so the thoughts that follow could be ridiculous.

There was a drop in the labor productivity growth rate that appears to be related to (and perhaps even caused by) the LFPR increase. The productivity drop does not appear to extend beyond the 1958 recession, but I couldn't say:

Graph #2: Labor Productivity, quarterly, 1950-1962

Using the initial "bounce" of growth, which typically follows recessions, as start- and stop-points for short-period comparison, Real GDP growth between bounces of the 1954 and 1958 recessions was noticeably low, relative to earlier and later periods:

Graph #3: Average of Annual RGDP Growth Rates, Including Bounces

Omitting the fore- and aft-bounces from the calculations, the average of annual growth rates shows an undeniable low between the 1954 and 1958 recessions:

Graph #4: Average of Annual RGDP Growth Rates, Excluding Bounces

In evaluating RGDP growth in the 1950s, keep in mind the high growth rates that were common in the early post-WWII period. This graph highlights RGDP growth during and after the 1955 LFPR increase:

Graph #5: Real GDP Growth, 1950-1962

There was, despite the slow economy, an unexplained "creeping inflation" during 1955-57. I want to say that, acting through a decline in productivity, the 1955 increase in the Labor Force Participation Rate was responsible for this inflation:

Graph #6: Three Measures of Inflation, 1950-1962

The deflator starts rising a bit early, but the PCE price index bottoms out in 1955:Q1, just where you might expect, and the CPI rise starts after June 1955.


Writing of Samuelson and Solow's 1960 paper, James Forder said:

The question they were addressing was that of the explanation of the inflation of the 1950s – particularly the period 1955-57 – and the implications it had for macroeconomics.

Nearing the end of their paper, Samuelson and Solow wrote:

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.

If they couldn't distinguish what type the inflation was, it's got to be safe to say they could not identify the cause of the inflation. 

They wrote in 1960. It's been a long time. Far as I know, which isn't far, I admit, the cause of the 1955-57 inflation was never discovered. It is still an open question: What caused the creeping inflation of 1955-57?

The cause of that inflation was the 1955 increase in the Labor Force Participation Rate. 

So that makes twice that an increase in LFPR created cost-push inflation by causing a fall in productivity. Twice in the US data.

//

The link to the Excel file with the "bounce" graphs

Household debt: An Alternative to the Wikipedia View

All of the Wikipedia references in this essay have been taken from the "Household debt" article on the evening of 9 April 2021.

 The opening statement:

Household debt is defined as the combined debt of all people in a household. It includes consumer debt and mortgage loans. A significant rise in the level of this debt coincides historically with many severe economic crises and was a cause of the U.S. and subsequent European economic crises of 2007–2012. Several economists have argued that lowering this debt is essential to economic recovery in the U.S. and selected Eurozone countries.

"A significant rise in the level of this debt" -- household debt, as opposed to government debt, nonfinancial business debt, and financial business debt -- "coincides historically with many severe economic crises..."

I am particularly uncomfortable with the view that household debt is the problem. Such analysis is, at the very least, oversimplified.

 

Under Historical perspective:

In the 20th century, spending on consumer durables rose significantly... Easy credit encouraged a shift from saving to spending.

No. Policy encouraged the shift from saving to spending; easy credit was only one aspect of policy.

Under Global economic impact:

"Household debt soared in the years leading up to the Great Recession. In advanced economies, during the five years preceding 2007, the ratio of household debt to income rose by an average of 39 percentage points, to 138 percent...

Yeah, okay. I don't know the specific percentages, but rapid debt increase leading up to 2007 is right. On the other hand, it is wrong to grab one fact and start drawing conclusions. Just as the financial crisis and Great Recession were consequences of massive, rapidly growing household debt, so too was the massive and growing household debt a consequence of that which came before.

We cannot wait until the shit hits the fan and then say Now there's the problem! We must not wait until it is too late. If accumulating debt leads to accumulating disaster, the time to act is not at the first evidence of disaster but at the first indication that growing debt is starting to slow the economy. Not in 2007, in other words, but in 1967.

Under U.S. economic impact: 

The policy prescription of Ms Yellen's predecessor Mr Bernanke was to increase the money supply and artificially reduce interest rates. This stoked another debt and asset bubble.

Note carefully that those sentences attribute both the solution and the problem to the central bank.

The central bank operates in an economic environment created largely by the U.S. Congress. The U.S. tax code for many many years, by allowing the tax deduction for interest paid, encouraged people to go into debt and to remain in debt. Only when debt had grown to the point that it was creating problems did Congress begin to eliminate the tax deduction. It was half-hearted. It was ill-conceived. And it came too late.

Eliminating the tax deduction at a time when debt was already creating problems only made the problems more severe. You would have had to eliminate the deduction by the early 1960s to beat the clock on this, and the fact that you don't believe that is part of the reason it didn't happen.

In any event it would have been better to replace the tax deduction for interest paid with a tax credit that reduces our tax payments when we pay down our debt ahead of schedule. Such a policy could be designed to create the same tax advantage for the taxpayer, while improving macroeconomic conditions by reducing our debt.

And this:

Economists Atif Mian and Amir Sufi wrote in 2014 that:

• Historically, severe economic downturns are almost always preceded by a sharp increase in household debt.

Again, we don't want to wait until the severe economic downturn is right on top of us.

And again, looking only at household debt gives us an incomplete picture. Here is household debt as a percent of GDP:

Graph #1: Household Debt as Percent of GDP

On the first graph, household debt appears to reach a horrifying high just in time to cause the Great Recession. But now look at that same household debt as a percent of All Sectors debt:

Graph #2: Household Debt as Percent of All Sectors Debt

Relative to the big debt number, household debt reaches its lowest peak just before the Great Recession. High peaks occurred in the mid-1960s when the economy was still good, but on the cusp, and in 1980 when the economy was already slowing due to excessive debt.

Look only at household debt and household debt looks like the biggest problem in the world. Compare household debt to all the debt, and you know in your bones that the problem does not lie in one piece of our massive accumulation of debt, but in the whole of it.

Under Effects on economic growth they quote Ezra Klein:

The utility of calling this downturn a “household-debt crisis” is it tells you where to put your focus: you either need to make consumers better able to pay their debts, which you can do through conventional stimulus policy like tax cuts and jobs programs, or you need to make their debts smaller ...

Number one: IT CANNOT BE DONE THROUGH CONVENTIONAL POLICY. Conventional policy is based on two notions, one true, one false:

• using credit is good for growth; and 
• the resulting debt does no harm.
  

The problem will not be solved by conventional policy until the conventions change. 

And remember, if the problem is debt, look at the whole problem, not just part of it. And when the problem is big enough to grab everyone's attention, the economy is telling you the problem has been growing worse for a very long time.

If anyone would know, she would

 

"Friedman rejected cost-push as a credible source of sustained inflationary pressure."

- Anna Schwartz

 

Interest-cost-push: Changes in interest cost NOPE, FORGET IT

Nope. I can't do it. Can't figure it out. I can't even tell if I'm close to right, or off by a mile. I will leave the post available, in case I need it.

The first two graphs are okay. It's the third graph, where I got inventive, that's the problem. That graph wants to show the percentage of a change in interest cost that is due to a change in interest rates. After finishing the graph, I posted the post and then started on a graph to show the percentage of a change in interest cost that is due to a change in outstanding debt.

I got another low percentage. Not as low as on Graph #3, but low. I should be able to add the part that's due to a change in interest rates and the part that's due to a change in outstanding debt, and get an answer that is equal to the change in interest cost.

Not even close.

I'm looking for evidence of cost-push inflation. Specifically, financial cost-push arising from the cost of interest.

"interest was definitely an increasing cost in those years"

I'm looking at the years before 1965. Before the Great Inflation. I'm looking for subtle but persistent increase of interest costs -- something one can find almost everywhere. I want to see the growth of interest cost relative to income (for households, disposable personal income), and in the business sector relative to profit or employee compensation costs or whatever makes sense when I get that far into it.

For households there is data going back to 1980, data on debt service (interest and principal payments) as a percent of disposable personal income (DPI). So I assume DPI is the appropriate context variable to use for my interest cost study.

The "Monetary Interest Paid" data for households is annual data starting at 1946. One version of this data is for households alone. Another version, which I used in the first graph, is for households and nonprofit organizations. I'm going to have to end up using the "households and nonprofits" version to be compatible with data that's called "household debt" but includes the debt of households and nonprofit organizations. For the next graph, I'll show both versions of the household interest cost, so you can see how nearly equal they are.

I'm using the annual version of  DPI, which goes back to 1929. The graph starts at 1946, where the interest data starts:

Graph #1: Household Interest Cost (two measures) as Percent of DPI 1946-1970
Note that the increase suddenly stops in the mid-1960s as
wages finally started participating in the wage-price spiral

Interest costs rose from roughly 1% of DPI in 1946 to 2% in 1952, to 3% in 1956, to 4% in 1962. Roughly. It's not exponential growth, but interest was definitely an increasing cost in those years. From start-of-data (1946) to the start of the Great Inflation (1965), interest cost increased by about 3.33% of disposable personal income (and DPI was itself growing at the time).

This interest cost increase works out to an average annual rate of increase of about 0.175 percent over the 1946-1965 period. Over three years, more than half a percent. Not a big number, but the increase was persistent. Subtle, but persistent.

The two lines, by the way, are very close. Nonprofit organizations add almost nothing to the household debt number. I'm going to drop the household-only data and work with "household and nonprofit".

I want to look at how much of the increasing interest cost was due to rising rates and how much was due to the growth of debt.

My method is to estimate interest cost for a given year based on the effective interest rate from the year before. I expect the change in interest to be proportional to the change in debt outstanding. Any discrepancy between expected interest cost and the given year's actual interest cost is attributed to a change in interest rates. 

The graph shows the portion of the change in interest cost that is attributable to a change in the effective interest rate: NOTE: It may not show that. I'm not sure now. I have conflicting graph results.

Graph #3: Rising Interest Cost is due mostly to Growing Debt, not to Rising Interest Rates

Before 1966 or so, interest cost due to rising rates averaged by eye a little above zero. From the latter 1960s thru the early '80s, inflationary years, the average ran closer to 5% of interest cost. After the early 1980s when the debt numbers were big and interest rates were falling, the portion of interest cost due to rising rates averaged a few points below zero. Nothing surprising there. My evaluations, however, like my averages, are only by eye.

As an indication of relevance: The deepest low, around 2001-2004, I think that's the same years John Taylor is talking about when he says interest rates were "too low for too long". 

 

More to come on the topic of financial cost-push and the cost of interest.

Occam's possibility

Real Time with Bill Maher, S19E10, 3/26/2021, with Brett Stephens, Caitlin Flanagan, Christopher Krebs.

In the monologue, Maher mentions the $3 trillion infrastructure spending proposed by President Biden. At the table he mentions it again. 

Brett Stephens replies three trillion is a lot of money. He makes reference to Brewster's Millions, where Richard Pryor's character "has to spend $30 million in thirty days, in order to inherit $300 million." Not sure what Stephens's point is, other than it's a lot of money.

Maher likes Biden's plan as "a Trojan horse for green energy".

In the New Rules part of the show, Maher says:

... looking at the economic factors right now, it feels like we're back in that head space that we'll never run out of cash as long as the Fed doesn't run out of ink.

He doesn't like the government spending. Still, he likes the Trojan horse for green energy.

I watch Real Time regularly. Maher is often very good, especially in the "New Rules". He is also often very wrong. For me, with my focus on the economy, Maher is often wrong about the economy.

He says things well. His line about running out of ink was good. But other than Maher's word choice, there is nothing new or interesting in what he said. It's the same old tiresome economic nonsense, dressed in a clown suit.

Here's the way our monetary system works: 

• The Fed loans money to banks so the banks can lend money to businesses and consumers. Businesses and consumers borrow. In addition, government borrows from people who have money that they don't need to spend. All this borrowing puts money in motion in the economy, and also creates a lot of debt.
• With all of that money in circular flow, there is money enough that debtors can grab some of it, pay off some debt, and reduce both the money and the debt in the economy.
• Some of the money in flow drops out of flow when people have a chance to save. Some drops out when we import stuff and pay for it. Economists say also that some money drops out of the flow when the government takes it in taxes. But you don't get to use that excuse if government spending is always in deficit.
• These changes to debt in the economy and money in flow happen repeatedly over many decades with no apparent problem. All the while, however, money is dropping out of flow, leaving more and more debt with no corresponding money that can be snatched from the flow and used to pay down debt. Over time it becomes more and more difficult to find the money to pay the bills. Of course we can always borrow more money if we need it. But that creates more debt. It does not solve the problem.
• Eventually, our bill-paying troubles grow severe enough that one unpaid debt can start a cascade of unpaid debts, and then you have a financial crisis.
  

That's how that all works. There's not really a problem that can be fixed by balancing the budget.

Graph #1

Hey, I don't like it either, the Federal debt going up so fast. But you know, I'm less prone to complain about the growth of debt than I am to say Graph #1 doesn't show the growth of debt. It shows the size of the Federal debt.

Graph #2 shows the growth that debt.

Graph #2

It's the same data, same graph as #1, except on #2 the vertical scale is a log scale, so the line takes a different shape and the graph shows growth instead of size.

#1 shows a lot of increase in the past 10 years. #2 shows increase but no acceleration (no curving upward) in the past 20 years. That's important. We're doing something wrong that makes debt increase, but at least we're not making it get worse faster. The line isn't curving upward.

Neither graph, by the way, shows how debt grew in response to covid. As of this writing, the data ends in 2019.

There are dangers that arise from our growing Federal debt. Most people who worry about it worry that it creates other problems for our economy, problems like inflation and crowding out. I'm sure there's a long list.

Such things are possible. But I would point out that a bigger problem is the "expectations" created by people who worry vigorously about the Federal debt. Worry about the Federal debt spreads because the worries are repeated so often. The growing worry can eventually create the problems that people fear. The same principle says inflation can be created by "inflation expectations" -- and economists warn of that one all the time. Debt expectations are just as real, but almost always ignored. That's troubling.

I prioritize the problems arising from Federal debt thus:

Low: Inflation, Crowding Out, Slow Growth, etc., caused by the debt.
Medium: The creation of expectations that lead to such problems.
High: The growing debt shows that we do not have control of the situation.

My strongest argument for containing the growth of Federal debt is simply to show that we can do it, to demonstrate that we have control of debt. Showing that we have control would solve the expectations problem.

Unfortunately, most people seem to think we know how to solve the debt problem, and we lack only the will to do it. That's nonsense. We've been trying to solve the debt problem since Reagan, without success. Forty years of failure. Forty years, maybe more. 

To make matters worse: The longer the Federal debt problem continues, the more people become committed to their debt solutions that don't work. Another word for that sort of extreme commitment is polarization.

 

In an old episode of Real Time (S17 E1, 18 Jan 2019), Maher said:

I don't really think there is a great need for new ideas because we've been around the same problems for decades. So we know what the ideas are. It's the political will to put them into play.

and John Kasich replied

I don't disagree with that.

I do. I disagree with Maher. His view is that "we've been around the same problems for decades" but we still haven't solved them, so we must not be trying hard enough. 

Maher does not see Occam's possibility: that our solutions don't work because we have the wrong solutions.

Maher and people like him -- most people -- think they know what the solution is. They do not. Nor do the people on the other side, the ones who say the Federal debt is not a problem and the government should spend whatever it takes to improve the economy. Those people want to put the upward curve into Graph #2. That's not a solution.

We misunderstand the economy. We do not know what the real problem is, and we're not trying to solve it. We're trying to solve the consequences arising from that problem. We do not understand that they are consequences. We do not wonder what problem they might be consequences of. The real problem remains, its consequences remain, and all our solutions come to naught.

Bill Maher's view -- we need to try harder -- is a commitment to failure. Maher is unwilling to re-evaluate things. He is unwilling to consider changing our problem-solving strategy. He only wants to try harder. He wants to continue using a strategy that has not worked for 40 years, and just try harder.

The trouble with Maher's approach to solving economic problems is that it is open-ended: As long as the problem is not solved, his solution is only to try harder. But if the problem you're trying to solve is a consequence of the real problem, you will never solve it. Because you cannot solve consequences.

The effective interest rate

If I have three different loans at three different interest rates, I can take the total interest I pay during a year and divide it by my total debt to get something called the "effective" interest rate.

My dumb-ass way of doing it is to take the total interest cost for one year, and divide it by the total debt I owe in the same year. Because it's easy to do at FRED, and I never thought twice about it.

But after making a lot of graphs showing debt, I know that debt totals are given as "end of period" data -- typically, the end of the year, or the end of the quarter. And thinking about it, it doesn't seem right to divide this year's interest cost by the amount of debt I will owe at the end of this year. I pay interest on what I owe, not on what I'm gonna owe.

The interest I owe this year is based on the debt I owe since the start of this year (or the end of the year before). I should divide this year's interest by the debt I owed at the end of last year. Thinking about it, I think that's right.

I should say, though, that I didn't think of it on my own. I read about it recently in an old PDF, the Fisher Dynamics PDF by Mason and Jayadev. On page 10 they write:

the effective interest rate [is] computed as the ratio of total interest payments to the stock of debt

 and on the following page:

The effective interest rate i is total interest payments divided by the stock of debt at the beginning of the period.

Or, since debt is measured as "end of period" totals, the effective interest rate is "interest paid" as a percent of "debt outstanding at the end of the year before."

But at least, now that I thought it through in my own way, I should be able to remember it. And since what I'm thinkin does correspond to the Mason and Jayadev calculation, I think I have it right.

Now what I want to know is: Does it make a difference? So I'm off by a year, so what?

I got the data for household debt from FRED, which is actually liabilities of "households and nonprofit organizations". Then I got the interest paid data for households and nonprofits. Then I moved the data to Excel:

Dividing this year's interest cost by last year's debt number gives a consistently higher effective interest rate than you get with the "same year" calculation. Yes, it makes a difference.

The orange line being higher means that I'm dividing by a smaller number: by a consistently smaller number. In other words, last year's debt number is consistently smaller than this year's debt number.

Yeah that's true. Our debt is growing all the time.

So the effective interest rate is higher than my "same year" calculation says, because debt is growing. This conclusion is confirmed by the graph since 2008, when the growth of debt suddenly slowed: The gap between the lines closes.

So much for the quantity theory of money

Of the 68 "monetary base" data series FRED lists for the United States, 64 of them have been discontinued.

Why does Google equate "empire" with "civilization"?

What -- We're not a civilization until we develop into an empire? Give me a break! The whole of "empire" is the decline-and-fall stage of civilization.