Thursday, November 26, 2015

Inflation adjustment of debt, again

Happy Thanksgiving!

I was looking for something... interest on government debt us... and came upon the nice, professional-looking site of Daniel Amerman, CFA. Pretty graphs, each on black background. One that really stands out is his interest rate graph, yellow on black. This is beautiful stuff.

Some interesting graphs, too -- interesting for what they show rather than how they show it. His first graph, titled "30 Year Earnings on $10,000 Investment", shows earnings for 1% interest versus 6% interest. The difference is staggering.

The graph that got me writing was Amerman's picture of the "US Federal Debt, 1947-1970 (Fiscal Years)". This graph:

Graph #1. Source: Daniel Amerman
It shows the Federal debt (top edge of the red area) and the Federal debt adjusted for inflation (bottom edge of the red area). As it says on the graph, the red area shows the "reduction in real debt" due to inflation.

So in 1970, for example, to pay back about $148 borrowed dollars it would take only about $85.

Well no, not really. It would still take $148 dollars to pay back $148 borrowed dollars in 1970. But $148 would only be worth about $85. I think that's Daniel Amerman's point. It's another way of saying "inflation erodes debt".

In 1947 it took $100 to pay off $100 borrowed ... in 1952 about $84 to pay off $100 borrowed ... in 1966 it took about $88 to pay off $125 borrowed. Yeah, yes and no. Interest aside, it always takes a dollar to pay back a dollar. But if there's inflation, the dollar you're paying back is worth less than the dollar you borrowed in the first place.

So, in 1952, the $100 you paid back was worth about $84. In 1965 the $125 you paid back was worth about $88. And in 1970 the $148 you paid back was worth about $85. That's what the graph shows.

But it is not really right. It assumes you did all your borrowing in 1947, or that you only borrowed dollars that were worth what a dollar was worth in 1947. And of course that is not the case.

Daniel Amerman's graph shows the Federal debt (as a percent of the Federal debt in 1947) and shows the value of that debt in inflation-adjusted dollars. But the inflation adjustment is based on starting in 1947. The graph assumes that all the dollars the Federal government borrowed were 1947 dollars.

Here, I checked my evaluation of the graph:

I downloaded annual data from FRED: GDP Deflator in the second column, and gross Federal debt in the fourth column. In the fifth column (Column E) I calculated "loss of value since 1947" numbers. Not loss of value. Retained value. If you borrowed $100 in 1947 and paid it back in 1952, the dollar was worth a little less, so you only paid back about $86.07 of the purchasing power that was in the $100 you borrowed in 1947. $86.07 is the retained value, what $100 from 1947 was worth in 1952.

See row 18, and column E. I selected Cell E18 and clicked a key to edit the cell, so you can see the calculation I put into that cell:


In that formula, the "B13" is blue -- and cell B13 has a blue box around it to make it easy to see what number is being used in the calculation. (Similarly, the text "B18" is red, and cell B18 has a red box around it.) The spreadsheet program puts those colors there automatically to make things easier to see when you're editing a cell.

I didn't actually want to edit the cell. I just wanted to show you the calculation I used. Further down in Column E (on row 31) there is the number 86 point something (for the year 1965) ... and (on row 36) there is the number 83 point something (for the year 1970). There was a number like that in the cell where we see the calculation, cell E18, but we can't see the number because that cell is in "edit" mode.

Before I activated edit mode, I copied the value from that cell up to the top of column E. On row 1, cells D and E you can read my note: Cell E18 = 86 point something.

The calculation in cell E31 (for 1965) is


The calculation in cell E36 (for 1970) is


Oh, and the calculation in cell E13 (for 1947) is


In each case I took the amount paid back, multiplied by the price index for 1947 (the assumed year-of-borrowing) and divided by the price index for the year-of-payback. Each calculation figures the value lost retained since 1947.

To summarize, the numbers I calculated were $86.07 (for 1952), $86.14 (for 1965), and $83.70 (for 1970). The numbers I got from Daniel Amerman's graph were $84 (for 1952), $88 (for 1965), and $85 for 1970. In each case my calculated number is off a little, compared to my estimate from the graph, but in all cases it is close. (The graph at FRED is also a little off from Amerman's. It's also off from what I expected: I indexed the FRED graph series to make it 100 in 1947, like Amerman's, but both lines came out below 100 for some reason. Close enough for government work, I guess.)

Close enough. I'm satisfied that what I said above is accurate: The assumption underlying Daniel Amerman's graph is that all the dollars borrowed by the Federal government were 1947 dollars.

But in fact not every dollar of Federal debt was borrowed in 1947.

Therefore, there is a error in the graph.

It's not only Dan Amerman's graph. It's almost every graph that shows the inflation adjustment of debt. You can't take a lump sum number like debt -- a number accumulated over many years in an inflationary economy where the value of the dollar changes over time -- and calculate the "real" value the same way you would figure "real" GDP. The calculation doesn't work for debt, because debt is accumulated over many years, and the value of the dollar changes over time.

To calculate the "real" or "inflation adjusted" value of debt, you have to adjust each year's addition to debt separately, using the price index for each year in turn.

Daniel Amerman's graph does provide some useful information. It shows that if we paid off Federal debt today, we'd be paying dollars that are worth less than the dollars we borrowed. But of course we're not going to pay off the Federal debt today. So I don't know how useful his graph is. Except it's useful to me, because it helps me show that the method commonly used to figure "real debt" is incorrect.

Monday, November 16, 2015


In a recent post Arnold Kling notes that both Scott Sumner and Tyler Cowen have offered "frameworks" or outlines of their macroeconomic thinking. In that post Kling presents a framework of his own. You know I had to take a look at all three.

Arnold Kling -- My Macro Framework:
... How do we get into messes? To some extent, each unhappy economy is unhappy in its own way. But some elements that one tends to find include Minsky-Kindleberger manias and crashes, sudden changes in credit conditions, sharp movements in important relative prices (oil, home prices), and permanent shifts in the skill structure of work.

It is a minor point. But if the question is How do we get into messes? then "sudden changes in credit conditions" is not the right answer. The sudden change in credit conditions *IS* the mess. What gets us into the mess is the long, slow, gradual change in credit conditions.

We start with a small accumulation of private sector debt and reach climax with a vast and unsupportable accumulation of private sector debt. This slow change is how we get into the mess. The moment that everyone suddenly realizes debt is excessive -- the moment of the sudden change in credit conditions -- in that moment we are already in serious trouble.

Sumner -- Is it time to blow up the New Keynesian model?
In the short run, employment fluctuations are driven by variations in the NGDP/Wage ratio.

Both NGDP and wages are nominal quantities. If you think of wages as a measure of the price level, you'll see that the NGDP/Wage ratio gives you a measure of RGDP. If this is correct, Sumner is only telling us that

In the short run, employment fluctuations are driven by variations in RGDP.

or maybe that

In the short run, variations in RGDP are driven by employment fluctuations.

And now perhaps it is obvious that Sumner is simply restating Okun's law.

That's okay. Maybe Scott Sumner secretly prefers old Keynesian to new Keynesian.

Tyler Cowen -- My macroeconomic framework, circa 2015
... stimulus to be effective needs to be applied very early in the ... recession.

Yes, that's correct. I called it urgency.

Tyler Cowen again:
Given that weak AD is only one of the problems in a bad downturn, and that confidence, risk, and supply side problems matter too, the best question to ask about fiscal policy is how well the money is being spent. The “jack up AD no matter” approach is, in the final political equilibrium, not doing good fiscal policy any favors.

Sumner's framework is a pretty well-focused piece of writing. So is Arnold Kling's. Cowen's strikes me as a jumble of semi-important points emerging from spontaneous free association. His "Given that weak AD" paragraph is a perfect example. He's got a whole list of things that matter, but he has not prioritized his list. He leaves it a mess, and from it draws the conclusion that we should ask a bad question about fiscal policy.

That question arose long ago in response to Keynes, who said that if lawmakers are prevented (by their misunderstanding of the economy) from spending on worthwhile objectives when fiscal stimulus is needed, then even spending foolishly would be better than failing to provide stimulus.

The question only arises if you misunderstand the point Keynes was making.

Dunno if I have a "framework" but I'll give it a go.

1. The economy is transaction. Exchange. Trade. Transaction. Everything that happens in the economy can be seen in monetary balances.

2. Don't worry about the real economy. The real economy takes care of itself. Look at the birds of the air; they do not sow or reap or store away in barns, but they get by.

3. Worry about monetary balances. When these get out of whack they do great harm to the real economy.

4. Cost is always a problem.

5. Don't make economics more complicated than it has to be.

Saturday, November 14, 2015

What would the new minimum wage be?

From Marx & MMT, Part 1 at heteconomist:
Labor of an ordinary or basic kind is called ‘simple labor’. Skilled labor is called ‘complex labor’ and is treated as a multiple of simple labor. The easiest way to make this reduction is to compare the wages (defined to include non-wage pecuniary benefits) of different types of labor. If the average wage is three times the minimum wage, society is behaving as if an hour of average labor is worth three hours of simple labor. In this way, all labor can be reduced to simple labor. The reduction is social, made by society itself, rather than necessarily natural or technical.

I'd rather think in terms of the average wage, not the minimum wage and multiples of the minimum wage. Much simpler. Beside the point.

I thought the ratio was an interesting idea -- the average wage relative to the minimum wage. So I went to FRED looking for it. To get a long-term view I ended up using average hourly earnings for production and non-supervisory employees in manufacturing.

Manufacturing has been in decline in the U.S. So any uptrend on the graph is probably muted because of my choice of data. And it looks like the average wage would be higher in general if supervisors' wages were added in. So, what Graph #1 shows is likely lower and flatter than we'd see if better numbers were used. (Oh, well.)

Graph #1: The Average Hourly Wage as a Multiple of the Minimum Wage
We see a sawtooth pattern because the minimum wage changes only occasionally. When the minimum wage is raised, the average wage is suddenly a smaller multiple of it, so the blue line drops sharply. Then the minimum wage stays the same while the average wage gradually climbs, and the blue line goes up for a while. This explains the sawtooth pattern.

The graph shows that from 1950 to 1970 the average wage was roughly twice the minimum wage -- in the neighborhood of 2.0 on the vertical axis. Then in the 1970s the average wage was a little higher, around 2.3 times the minimum wage. And since the mid-1980s, the average wage has been higher yet -- near 3 times the minimum.

Okay. So during the "Golden Age" the average wage was about 2 times the minimum wage, and during the "Great Moderation" the average wage was about 3 times the minimum wage. Call it 2.8 times the minimum wage. Just about where it is now.


I took the minimum wage, the average wage (the same one as in Graph #1) and the Consumer Price Index and put 'em all on a graph together. I "indexed" them so they're all equal in January 1952. Each has the value 100 in January 1952. Why January 1952? Because at that time the average wage was almost exactly two times the minimum wage. I set them equal in order to see which went up faster and which went up slower.

Graph #2: A Comparison of Increase -- the Average Wage, the Minimum Wage, and the CPI

The blue line went up faster. That's the average wage. It went up faster than the red line (the minimum wage) since around 1970, definitely.

The two government statistics -- the minimum wage and the CPI -- follow each other pretty closely, and both of them are well below the average wage since the 1980s. Among other things, this tells me that yeah, the CPI understates inflation.

(Remember, the blue line excludes supervisors' wages and considers only the wages of the manufacturing sector, not a strong growth sector in the U.S. economy. So the blue line understates the average wage. And the green line is even less. The minimum wage runs with the understated inflation number.)


We know from Graph #1 that the average wage went from two times the minimum wage to 2.8 times the minimum wage.

We know from Graph #2 that the average wage went up faster than the minimum wage.

Suppose we wanted to raise the minimum wage so the average was only 2 times the minimum again, like in the 1950s and '60s. What would the new minimum wage be?

Well, in September 2015 the minimum wage was $7.25. The average wage was $20.06. To make the average wage twice the minimum wage, the minimum wage would have to go up to $10.03.

$10.03 of Graph #2 would bring the red line straight up to where it just touches the blue line. Then the red line would run flat again until the next increase (if ever). So probably we would want to make the red line go a little higher than the blue. We might want to raise the minimum wage to $12 or so.

Maybe that's where the $12 number comes from.


Google turns up calls for a $15 minimum wage. I had to go looking for $12. First thing that turned up was Tim Worstall's A $12 Minimum Wage Would Cost 777,000 Jobs And Wouldn't Reduce Poverty Much Either.

Worstall says a $12 minimum wage "would cost some three quarters of a million jobs".

I was thinking...

$12 puts the minimum wage back where it once was, running neck-and neck with half the average wage. (Yeah, yeah, the average wage has been lagging too; maybe that's where the call for a $15 minimum comes from. But that's another story.)

$12 puts the minimum wage back where it was during the "Golden Age" of the 1950s and '60s. But Tim Worst all says going back to the Golden Age standard would cost us jobs. I think he's full of opinion.

Graph #3: The Minimum Wage, Neck-and-Neck with Half the Average Wage Until 1970

Thursday, November 12, 2015

"Where has the vanishing labor force gone?"

So where have they gone? How are they supporting themselves? Well, the above linked study published by Princeton last week gives us an inkling about what’s become of them. They’re living in despair. And they’re dying.

Recommended reading: Where has the vanishing labor force gone? Now we have a clue. at "Five Short Blasts" Forum.

Wednesday, November 11, 2015

Williamson versus the world

The World:

The Queen of England was standing in a hall at the London School of Economics looking a little perplexed. The date was Novem­ber 4, 2008, and she had arrived to open a new building on campus...

The event was supposed to be a celebration of academic achievement, but the timing was poignant. Two months earlier, the financial crisis had erupted in London and many other parts of the West, leaving hordes of economists and pundits scurrying to provide analysis. As the Queen toured the build­ing, Luis Garicano, one highly regarded economist, pre­sented her with some charts that purported to show what was going on in finance.

The Queen peered at the brightly colored lines. “It’s awful!” she declared, in her clipped, upper-­class vowels. “Why did nobody see the crisis coming?”

The Queen asked the question everyone was asking. And hordes of economists were trying to figure out what happened. Meanwhile, Steve Keen pointed to two studies that between them found a total of 16 economists who saw the crisis coming:

A majority of the 16 individuals identified in Bezemer (2009) and (Fullbrook (2010)) as having anticipated the Global Financial Crisis followed non-mainstream approaches ...

And not even Alan Greenspan anticipated the crisis, though Congress thought he ought to have:

Committee Chairman Henry Waxman, (California Democrat) said to those present: The reasons why we set up your agencies and gave you budget authority to hire people is so you can see problems developing before they become a crisis. To say you just didn't see it, that just doesn't satisfy me. Finally, Greenspan told the lawmakers that regulators could not predict the future ...

Stephen Williamson, however, sees things differently. He sees not only "the" future, but all possible futures -- and he knows what is likely, and what is not:

In principle, the current state of the economy determines the likelihood of all potential future states of the economy.


Monday, November 9, 2015

Antonio Fatas and the Chain of Causality

From GDP growth is not exogenous by Antonio Fatas:
Ken Rogoff in the Financial Times argues that the world economy is suffering from a debt hangover rather than deficient demand. The argument and the evidence are partly there: financial crises tend to be more persistent. However, there is still an open question whether this is the fundamental reason why growth has been so anemic and whether other potential reasons (deficient demand, secular stagnation,…) matter as much or even more.

The Ken Rogoff opening is an attention-grabber. I'm sure you remember Reinhart and Rogoff and the 90% threshold -- when public debt reaches 90% of GDP, they said, bad things happen to economic growth. You remember.

But I remember something else Rogoff said, after that, in Debt supercycle, not secular stagnation at VOX:
I will argue that the financial crisis/debt supercycle view provides a much more accurate and useful framework for understanding what has transpired and what is likely to come next...

The evidence in favour of the debt supercycle view ... includes the magnitude of the housing boom and bust, the huge leverage that accompanied the bubble, the behaviour of equity prices before and after the Crisis, and certainly the fact that rises in unemployment were far more persistent than after an ordinary recession that is not accompanied by a systemic financial crisis. Even the dramatic rises in public debt that occurred after the Crisis are quite characteristic.

See it? Even the dramatic increases in public debt, he says. This time Rogoff is clearly not saying the big increases in public debt are the cause of our troubles. Those increases "occurred after the Crisis", he says. Consequence, he says, not cause.

The Rogoff article linked by Antonio Fatas is dated 9 October 2015. From the opening:
What is the right diagnosis of the ailing global economy? ...

Some argue that we are living in a world of deficient demand, doomed to decades of secular stagnation. Maybe. But another possibility is that the global economy is in the later stages of a debt “super cycle”, crushed under a burden accumulated over years of lax regulation and financial excess.

I had to look. Fatas says Rogoff "argues that the world economy is suffering from a debt hangover rather than deficient demand." I had to check that. When I read Fatas, I thought he might be misinterpreting Rogoff. He's not. He's right. Rogoff sees secular stagnation as one possibility, and crushing debt as "another possibility".

Rogoff sees the excessive debt explanation as an alternative to the deficient demand explanation.

That's just plain silly. Excessive debt is not an alternative to the "deficient demand" explanation. Excessive debt is the cause of deficient demand. First, the growing cost of growing debt consumes a growing portion of income. So demand atrophies gradually at first. Then, people suddenly come to think of their debt as excessive, and they suddenly cut their borrowing and spending. Demand falls suddenly -- economists call that a "shock" -- and we have "deficient demand".

Let me start again. Antonio Fatas:
Ken Rogoff in the Financial Times argues that the world economy is suffering from a debt hangover rather than deficient demand... However, there is still an open question whether this [debt hangover] is the fundamental reason why growth has been so anemic and whether other potential reasons (deficient demand, secular stagnation,…) matter as much or even more.

No. It's not an open question. Excessive debt is the cause of deficient demand. Secular stagnation is the result.

Saturday, November 7, 2015


Brad DeLong:
Indeed, back in 2000 it was Ben Bernanke who had written that central banks with sufficient will and drive could always, in the medium-run at least, restore full prosperity by themselves via quantitative easing. Simply print money and buy financial assets. Do so on a large-enough scale. People would expect that not all of the quantitative easing would be unwound. Thus people would have an incentive to use the extra money that had been printed to step up their spending.

The goal, see, was to get people to "step up their spending". But, as DeLong says, the result "has been unexpectedly disappointing".

I think that's why central banks these days are thinking about going cashless. It's the next logical step in the plan to get people to step up their spending.

The trouble is, it's not a good plan. It's a major change to life as we know it -- to life as we've known it for millennia, I guess, since cash money was first invented.

It's a major change, tacked on as an afterthought to a plan that didn't work, the plan to get us to step up our spending. It's an afterthought tacked on to a plan that didn't work.

If we're going to abandon cash, shouldn't we put a little more thought into it than that?

Wednesday, November 4, 2015

Say "OOF"

Here's what I'm looking at:

Part of this page as of 31 October at six in the morning, my time.

I'm there because of the post. Dillow points out "the general public's lack of understanding of economics" and says: "people underestimate the tendency of emergent processes to produce benign outcomes".

Snort. Maybe people lowball the economy's tendency to produce benign outcomes because the outcomes are generally not benign.

But that's not what got me writing this morning. What got me writing was that I read those two links in his sidebar, the ones in red boxes.

The Search for Yield

"Search for Yield" links to Rational and Behavioural Drivers of Financial Markets: the case of ‘search for yield’ by Silvia Pepino:
The ‘search for yield’ (or ‘reach for yield’) observed in financial markets in recent years is a striking manifestation of the interaction of rational and behavioural factors. During an extended period of low interest rates and volatility, market participants have displayed a tendency to seek higher returns by investing in securities that carry higher credit, liquidity or duration risk.

... financial market practitioners and policy makers generally refer to ‘search for yield’ as the tendency of investors to take on higher risk in exchange for higher expected returns when interest rates are low...

In recent years, against the backdrop of very low interest rates and quantitative easing, a tendency has developed among investors to accept higher duration, credit and liquidity risk in order to boost returns.

... a tendency to ‘search for yield’ in financial markets can become a reason for concern, particularly when it is perceived to become excessive and lead to under-pricing of risk.

The article is about rational and behavioral "drivers" of the search for yield. I'm ignoring drivers. I'm focusing on the tendency of investors to take on higher risk in exchange for higher expected returns when interest rates are low.


Everyday stagnation

"Everyday stagnation" links to Chris Dillow's post at Investor's Chronicle. (You may have to register to read it.)
One of the few drawbacks of working from home is that one is bombarded with annoying phone calls from time-wasters...

All those cold callers give us a daily - well, hourly - reminder that the economy isn't dynamic enough to create sufficient productive and rewarding jobs. In other words, we are in an era of secular stagnation. This phrase has many meanings; it refers to the combination of slow productivity growth, weak investment and low innovation that have given us negative real interest rates...

Stagnation, though, hasn't only given us poor returns on cash. It has also depressed equity returns.

A recent paper by Gianluca Benigno at the LSE and Luca Fornaro at Barcelona's University of Pompeu Fabra points out that economies can fall in a stagnation trap. If people expect low growth they won't invest or innovate and this will cause low profits for other companies, thus exacerbating disincentives to invest. In this way, pessimism can be self-fulfilling.

The problem is that such pessimism might be justified.

One reason for this is that profit rates have fallen. The economics blogger Michael Roberts estimates that returns on capital in G20 countries have steadily fallen since the early 1970s.

Production is the source of profits, the source of "yield". The yield to financial markets pulls yield away from productive markets.

Growing financial profits reduce productive sector profits. Falling profits in the productive sector reduce growth, productivity, investment, and innovation. This leads to lower interest rates and depressed equity returns.

Growing financial profits undermine the source of profits. Let finance gain at the expense of the productive sector, and you set the stage for reduced yield in financial markets.

The problem is not "pessimism". The problem is "OOF": Onerous overgrown finance.

Tuesday, November 3, 2015

The Neutral Zone

As I write this, it is 9:32 AM on Sunday morning. Would have been 10:32, but we sprung back while I was sleeping. Scheduled for 4 AM Monday I have "Are we tight yet?" where I review an article about the Fed's problem in finding the neutral rate of interest. Therein I say:
If we define "the neutral rate" as the article does:

"the borrowing cost -- adjusted for inflation -- that keeps the economy at full employment with stable prices"

then I'm not even sure the neutral rate exists. Since the crisis, I mean.

At Marginal Revolution: What’s the natural rate of interest? Tyler Cowen writes:

Whether a given rate of interest both maintains full employment and stable inflation depends on the rate of productivity growth, for one thing. It can be that no single rate of interest can perform both functions.

Pretty much what I said.

I like the whole Marginal Revolution article. Lots of links that look most interesting. And a very good quote from Milton Friedman (of all people!).