"started by over-indebtedness."

From mine of 10 June of this year:

Debt-to-GDP? Really?? GDP is highly unstable, and probably affects the ratio more than debt does. I'm reminded of something Scott Sumner said. In comments on Debt surges don’t cause recessions, Vivian Darkbloom "ran across another [debt-to-GDP] chart", one that goes "back to 1920". Vivian provided a link to an old Steve Keen site but the link no longer works, so I can't show the graph.

But based on Scott Sumner's response, I'm pretty sure the outstanding feature of that graph was the massive spike associated with the Great Depression:

Vivian, Thanks for that graph. Here’s my prediction: 99% of people will misread that graph. Most will think it shows a debt bubble before the Great Depression. In fact it shows there was no debt bubble before the Depression. Rather the debt ratio rose DURING the Depression, but only because the denominator (NGDP) fell.

I agreed with Sumner that the debt ratio rose sharply "DURING the Depression" and that it rose because the denominator fell. Again, GDP is highly unstable, and probably affects the ratio more than debt does. But I didn't just agree with Sumner and let it go; I said "Agreed. But ..."

Agreed. But if you were around in 1910 or 1920, the Roaring 20s probably looked very much like a debt bubble. It's not that "there was no debt bubble before the Depression", but that in hindsight the bubble is insignificant when compared to the debt spike of 1929-1933.

And when compared to the debt we've accumulated since that time.

This comes up because I was reading Irving Fisher, writing in 1933:

36. The depression out of which we are now (I trust) emerging is an example of a debt-deflation depression of the most serious sort. The debts of 1929 were the greatest known, both nominally and really, up to that time.

Sumner can say what he wants about "no debt bubble before the Depression" but I'm going with Irving Fisher, who said the debt before the Great Depression was the most debt ever accumulated -- up to that time.

Also from my June post, this graph from Martin Wolf:

The vertical line just before 1930 shows the start of the Great Depression. The sharp increase after that, just to the right of that line, is the debt ratio rising because GDP fell, as Sumner says.

To the left of that vertical, we see what happened leading up to the Great Depression. Debt was a little high in the 1870s, about 150% of GDP. Then it fell to around 125%. From that low, debt increased persistently for 50 years, reaching almost 200% of GDP; this happened before the Great Depression.

That persistent increase from 125% to 200% produced what Fisher called the "greatest known" debt. It looks low on the graph today because debt has gone so much higher since that time. But that 50-year increase in the debt ratio paved the way for the Great Depression. As Fisher has it:

19. I venture the opinion, subject to correction on submission of future evidence, that, in the great booms and depressions, each of the above-named factors has played a subordinate role as compared with two dominant factors, namely over-indebtedness to start with and deflation following soon after...

Over-indebtedness, to start with. Couldn't be more clear on the cause of the troubles. Couldn't be more clear. On the cause of the troubles.

21. Disturbances in these two factors—debt and the purchasing power of the monetary unit—will set up serious disturbances in all, or nearly all, other economic variables. On the other hand, if debt and deflation are absent, other disturbances are powerless to bring on crises comparable in severity to those of 1837,1873, or 1929-33.

Yes, and we can now add 2008-09 to that list. The "future evidence" is in. Fisher was right.

22. No exhaustive list can be given of the secondary variables affected by the two primary ones, debt and deflation; but they include especially seven, making in all at least nine variables, as follows: debts, circulating media, their velocity of circulation, price levels, net worths, profits, trade, business confidence, interest rates.
23. The chief interrelations between the nine chief factors may be derived deductively, assuming, to start with, that general economic equilibrium is disturbed by only the one factor of over-indebtedness...

The conclusion to that last sentence is other things equal, the perspective commonly employed by economists.

And then, this:

Paragraph 24 above gives a logical, and paragraph 27 a chronological, order of the chief variables put out of joint in a depression when once started by over-indebtedness.

"started by over-indebtedness."

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

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

Akerlof, on financial crashes:

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

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

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

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

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

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

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

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


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

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

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

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

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


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

I said:

What people do depends on economic conditions.

Morris and Shin open with this thought:

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

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

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


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

What I was working on yesterday

They interrupt me to advertise, now

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

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


"SUPPORT FOR OFFICE 2010 ENDING OCT 13, 2020"


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


They suggest that I click "Tell me more"

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

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

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

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

The business interest expense deduction since TCJA

According to Thompson Greenspon,

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

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

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

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

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

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

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

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

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

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

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


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

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

The Thompson Greenspon page explains this third option:

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

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

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

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

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

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

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

Politics and the economy

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

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

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

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

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

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

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

TURNER: Ask them.

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

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

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

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

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

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

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

At that point, I was sayin GO, JOE!

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

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


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

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

This, however, is an erroneous conclusion.

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

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


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

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

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

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

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

The economy drives politics.

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