A Key Quote from Samuelson and Solow (1960)

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

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

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

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

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

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

Josh Hendrickson concurs:

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

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

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

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

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

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

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

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

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

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

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

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

Paul Volcker on the tradeoff

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

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

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

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

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

The Volcker Experiment

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

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

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

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

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

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

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


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

in 1984 the Federal Reserve officially discarded monetarism

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

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

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

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

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

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

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

"Oops."

Household Debt Service by Vintage since 1999

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

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

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

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

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

Your basic For/Next loop.

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

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

Here's the graph as FRED shows it:

Graph #1

Here's what the ALFRED data gave me:

Graph #2

You can click the second graph for an enlarged view.

Samuelson and Solow (1960):

"But in the modern world, all or most wages are increasing." -- Page 362


... and then there's Google (2019):

Google starts like this now?

What the fuck?

?

How many questions you want, Goo?


Well, at least they don't say "Ask me a question".

Looks like vigor to me

Went to Harbor Freight the other day. When I left, there was so much traffic I had to fight my way out of the parking lot -- at one p.m. on a Friday in October.

Two days earlier, traveling with the wife: A lot of traffic, enough that she commented on it. Mid-morning on a Wednesday, a week before Halloween.

Not particularly busy times of the day. Not weekends or holidays or special days. Just ordinary days. But roads and parking lots were busy. It happens once, you don't think twice about it. It happens again, you have to stop and look. To me, it looks like economic vigor.

Then too, there are three or four new houses going up a mile down the road from me. I haven't seen that kind of activity since the '90s. Looks like vigor to me.

//

Ten years back, every time you turned around somebody was saying there's gonna be inflation, bad inflation. Because of Ben Bernanke and "Quantitative Easing". It got to the point, it seemed they wanted inflation, bad inflation. Whatever the reason, I don't know, but you heard the prediction so often it seemed like they wanted things to go bad.

Lately, last couple years maybe, it's been like that with predictions of recession: There's gonna be a recession in 2018. Then: There's gonna be a recession in 2019. Then: 2020. Now? 2020 or 2021. It's like they want it to happen.

Desire influences the predictions, no doubt. That's the trouble with politics.

//

Back in March of 2016 I predicted economic vigor: "This is going to be the full tilt, rapid output growth, rapid productivity growth, high performance boom."

In April 2016: "In two years everyone will be predicting it."

And in August: "The stage has already been set for the vigor that will be attributed to our next President."

Well it's been over three years now, and I've been hearing nothing but predictions of recession. Oh, there was a flurry of media reports a year or two back, about how "good" the economy was doing, two percent growth and all. Two percent is not good growth. Vigor means four percent, and hints of more. We're not there. The economy is not "good". Some people set the bar way too low.

I was wrong about vigor starting to be obvious by 2018. And the repeated refrain of recession has recently raised doubt in my mind that we'll ever see vigor again.

The numbers aren't there. Private debt is still painfully high, by any measure:

Graph #1

And "Debt Service" continues to drift downward:

Graph #2

It had started going up again, but that fizzled. So I've been thinking about writing a post to say my prediction of vigor was wrong. But now I don't know. Houses are being built, and parking lots are crowded. Things are busy, and busyness means business. This year we could have the best holiday shopping season we've seen in a decade or more. We will soon see.