Sunday, August 30, 2015

Must-Re-Think: Yes, you do need to rethink this.


... a strongly negative natural real safe rate of interest (there’s at mouthful!) will cause sigificant problems ...

Brad DeLong seems to be a first-draft blogger: as if he has no need, ever, to go back and check his work... to fix a spelling mistake... to get rid of the extra words that muddy his meaning... to use a goddamn comma once in a while. None of that.


I don't often read the guy, because I have to fight with his sentences to figure them out. Even his titles are too long. I'm looking at Must-Re-Read: Paul Krugman: Secular Stagnation, Coalmines, Bubbles, and Larry Summers.

DeLong's post is about "a division in the ranks" among economists who agree with him on what the problem is. The division arises when it comes to a solution:
Some of us–Rogoff, Krugman, Blanchard, me–think our deep macro economic problems could be largely solved by the adoption and successful maintenance of a 4%/year inflation target in the North Atlantic. Others–Summers, Bernanke–do not.

If these guys are offering solutions, and their solutions don't agree, then maybe they ought to check their work: Re-Analyze the problem to see what the problem really is. And then come up with a solution.

Anyway, the solution offered by "some" of them -- Rogoff, Krugman, Blanchard, and DeLong -- is to double the target rate of inflation, and hit that target.

I don't like it. The problem is not that prices are too low.

Oh, hey. "Inflation" -- defined as an increase in the general level of prices (where "the general level of prices" by definition includes the price of labor, or wages, so that inflation lifts all boats) -- inflation erodes debt. Inflation encourages spending. Inflation is associated with growth. All of that.

No shit. But the problem is not that prices are too low.


"When economists write textbooks or teach introductory students or lecture to laymen, they happily extol the virtues of two lovely handmaidens of aggregate economic stabilization -- fiscal policy and monetary policy." - Arthur Okun

When I went back to school for a course in Macro in the '70s, I learned we had two goals and two policies. The policies were monetary and fiscal. The goals were price stability and economic growth.

I am embarrassed for economists. They once knew our goal to be price stability. Now they know it as inflation stability and argue about where to stabilize it. Oh my god. Milton Friedman must be turning in his grave. Maynard Keynes must be turning in his.


DeLong opens his post with a conflict: Some economists agree [with him] that higher inflation will solve the problem. Some don't.

Delong presents his view: "our deep macro economic problems could be largely solved" by higher inflation. But he does not describe the opposing view, except to say that those who hold it reject his view.

According to DeLong, the opposing view is that there will still be "sigificant [sic] problems even if 4%/year inflation allows a demand-stabilizing central to successfully do its job". Did you notice? DeLong does not attempt to understand (or even to state) the opposing view. He only restates his own view -- and adds negativity.

He could still try to understand the other side's position, of course. But instead, he tries to explain why his inability to understand their view bothers him so:

I would have said that my mental model of Bernanke thought is very good. And I would have said that the sub-Turing evocation of Summers that I am currently running on my wetware is world-class

I did say tries to explain.

That is all that there is of DeLong's contribution to the post. (It's just as well, really.) The rest of the post is made up of excerpts from those who share his view. You know: Rogoff, Krugman, Blanchard, DeLong. Oddly, the excerpts come from Paul Krugman, Gavyn Davies, Paul Krugman, and Jared Bernstein.


Well, DeLong is right about one thing: I did have to re-read his post. Here's why: In his introductory paragraphs, DeLong admits to being disturbed by disagreement between two groups. The DeLong group holds that higher inflation will solve the problem. The other group holds it will not.

"My failure to comprehend why they think this disturbs me," he says.

Maybe he means he is coming around to their point of view. Wow! It's pretty well hidden, if that's what he means. But let me tell you why I think that might be the case.

In the first excerpt, Paul Krugman says "I very much fear that [Larry Summers] may be right."

In the second excerpt, Gavyn Davies says if the other guys are right, inflation won't solve the problem: "... the problem of under-performance of GDP will last for a very long time, and will not solve itself through flexibility in prices"

In the third excerpt, Krugman favors higher inflation, but still has doubts:

One answer could be a higher inflation target, so that the real interest rate can go more negative. I’m for it! But you do have to wonder how effective that low real interest rate can be if we’re simultaneously limiting leverage.

In the fourth excerpt, Jared Bernstein favors higher inflation, but still has doubts:

I’m totally with the program re getting the real interest rate down… But I’m nervous that it might not be as effective as historical correlations would suggest.

In those excerpts together, there is as much doubt as support for a policy of 4% inflation. So I think DeLong is telling us he's having second thoughts. Soon, he will abandon the DeLong group.

In his first paragraph he's firmly in favor of 4% inflation as a solution to "our deep macro economic problems". In his second paragraph he is disturbed by other views. In the rest of the piece, he dwells on the fears, worries, concerns, and doubts of others. Brad DeLong is preparing to change his views on the effectiveness of higher inflation as a solution.

My respect for Brad DeLong just hit a record high.

But listen, Brad, buddy, we don't have time for this. We're six years into the sinkhole. You gotta get your act together.


I want to take bits and pieces from the excerpts DeLong provides, to see if I can come up with something he might have missed.

Krugman(2): "When the Minsky moment came, there was a rush to deleverage; this drove down overall demand for any given interest rate, and made the Wicksellian natural rate substantially negative, pushing us into a liquidity trap…"

When the Minsky moment came, there was a rush to deleverage, Krugman says. But I suspect we knew the Minsky moment had come because there was a rush to deleverage. It's not like the Minsky moment came and then we all said let's get out of debt now. The Minsky moment is just the name for that moment when there's a rush to deleverage.

Other than that, Krugman's statement is one long trail of theory. See how he takes an actual event -- the rush to deleverage -- and buries it in layer after layer of theory? It drove down demand... it made the natural rate negative... it created a liquidity trap. This is as good an example as I have ever seen of an economist who needs to go back and rethink the problem: First see what the problem really is. Spend a lot of time on that. Then consider solutions.

Krugman's thought process doesn't start with deleverage. It starts with the liquidity trap. It starts with his conclusion.


Krugman(1): "The underlying problem in all of this is simply that real interest rates are too high…. The market wants a strongly negative real interest rate, [and so] we’ll have persistent problems until we find a way to deliver such a rate."

What the market wants is to be out of debt. Remember the rush to deleverage? Stop focusing on negative real interest rates and other elegant claptrap. Focus on facts.

As of this moment, we're still not ready to rush back into leverage. That's why we still have large output gaps and no evidence of price pressures.


Bernstein: "Many years post-panic, we still have large output gaps and no evidence of price pressures. The zero-bound is constraining Fed policy..."

Fuck the zero bound. That's not the problem. It's a result. Many years post-panic, we still have large output gaps and no evidence of price pressures because we're still delevered.


From mine of 22 September 2012:
The problem is not that prices are too low. The problem is that growth is too slow. There is only one correct focus, and it is to understand the reason growth is slow.

For the record, as long as economists continue to dismiss out of hand the possibility that excessive private sector debt is the reason growth is slow, economists will continue to fail to understand slow growth.

Maybe that's confusing. I just took a lot of your time to tell you the rush to deleverage was the problem. Then I say excessive debt is the problem. Do you see how those pieces fit together?

The excessive private sector debt was the cause of the rush to deleverage. When the excessiveness of it finally hit home, deleverage was the only option left. Excessive debt was the problem that caused the deleverage problem that caused the negative real rate problem that caused the liquidity trap problem. That's how the pieces fit.

Okay. But I also said growth is slow because debt is excessive. But it's the deleveraging that slowed things down. How do those pieces fit?

Gavyn Davies: "The normal route through which monetary policy works, by bringing forward consumption from the future into the present, is unlikely to be successful… There will still be a shortage of demand when the future comes around".

Bringing forward consumption from the future into the present is accomplished by spending future income in the present. In other words, by the use of credit.

We have policies to encourage the use of credit. Indeed, as Gavyn Davies says, that is the normal route through which monetary policy works. (Tax policy also encourages credit use, through tax deductions.) These policies accelerate the use of credit.

We have policies to accelerate the use of credit. But we have no policy to accelerate the repayment of debt. Therefore, debt accumulates to unnatural and excessive levels. The cost of that debt hinders economic growth, fosters the growth of finance, and drives the inequality of wealth and income.

Yadda, yadda, yadda, and rather than raising interest rates to fight inflation, policy must accelerate the repayment of debt to fight inflation.

Thursday, August 27, 2015

Brad DeLong's Freudian Slip


From Must-Re-Read...
... economists who I think have some idea of what the elephant in the room us.

Tuesday, August 25, 2015

Where's the Explosion?



The blue line shows the rate of change in the Federal debt.

The red lines are calculated trends for the periods 1948-1965, 1965-1984, and 1984-2000.

In which period did the "explosion" of debt occur?

Monday, August 24, 2015

The Federal Debt Graph with a Constant-Growth-Rate Denominator


I was saying Noah's picture of debt growth is distorted by a wandering denominator: by a GDP that suffers from a variable and inconsistent rate of increase.

It occurs to me that we could get a better picture of debt growth by faking the GDP numbers. Rather than using actual values, we can calculate a set of values that approximate the GDP numbers, but are based on a constant rate of growth.

I didn't do any of that "least squares" crap or anything like. I just picked 1947 for a startpoint and 2000 for an endpoint, and figured out a constant growth rate that would get me from the 1947 GDP number to the 2000 GDP number. It is completely subjective (or arbitrary, really) and if you know how, you could probably come up with a better series of constant growth rate values. Meanwhile, I got what I got and I'm going with it.

Graph #1
Graph #1 shows actual (often called "nominal") GDP in red, and my constant-growth-rate numbers in blue. You can see that the lines cross some time around the year 2000. (Exactly in the year 2000, actually, as that year was one of the defining points of the blue curve.) By design, the lines also cross in 1947, though we would have to "zoom in" to see it clearly.

The lines also cross around 1977, but this is not because I pinned them together at that point. Actually, that is information the graph gives us. (That is the reason for making the graph!) Now, looking at those three crossing points, we can say the red line runs below the blue for some years before 1977, then above the blue until the year 2000, then again below the blue.

In more familiar terms, we might say GDP growth was less than average before 1977, above average from 1977 to 2000, then again below average. Obviously this is not correct. It is the result of picking 1947 and 2000 as my arbitrary start- and end-dates. If I had picked 1966 or 1973 as an end-date, the whole rest of the blue line after that date might have been above the red.That would have been a better look at economic growth.

But the purpose of this exercise is not to find the point that economic growth began slowing. The purpose is to approximate the GDP we actually got, using a constant rate of growth. For that purpose, the blue line looks about right to me, up to 2007 anyway.

You with me? Do not imagine that Graph #1 shows periods of better-than-average and worse-than-average growth. It does not.


Saturday's post showed this comparison of growth rates for actual GDP (red) and the Federal debt (blue):

Graph #2. Click Graph for FRED Source Page
It is pretty easy to see that the Federal debt jumps up above GDP growth just after the 1982 recession. But if you take a second look you might notice that the red line wanders upward until the late 1970s, which makes the simultaneous increase in the blue line appear less significant. And then the red line wanders downward for 20 years or so, making the increase in the blue line look more significant. The changes in actual GDP contribute to making the change in Federal debt seem like a sudden increase that occurs after 1982.

Like Noah, we are deceived.

The growth rate of actual GDP varies, as the red line on Graph #2 shows. The growth rate of my "constant growth" GDP does not. This approximate measure (the blue line on Graph #1) has a constant annual growth of about 7.25%. Plotted on a graph, the growth rate is a flat (horizontal) line.

I took the numbers I used for Graph #1, worked out the annual growth rate values for them, and made a new graph:

Graph #3
The proportions of Graph #3 differ from those of Graph #2 but, that difference aside, the blue lines on the two graphs are the same. (Both blue lines represent the growth of Federal debt.) But on Graph #3, I show the growth rate of the "constant growth rate" GDP approximation. A flat, red line near the 7.25% level for the full period shown on the graph.

On Graph #3 it is pretty easy to see that the Federal debt jumps up above GDP growth just after the 1974 recession. That's the 1974 recession, not the 1982 recession. It is now quite obvious that a sudden increase in Federal debt growth occurs some eight years earlier than we thought!

The difference is not due to any changes I made to the blue line. I made no such changes. I only changed the red line from a wiggly worm to a constant (average growth rate) value, so that the red line does not obstruct our view of the blue line.


Almost done.

We've been looking off-and-on lately at a picture of the Federal debt relative to GDP, this FRED graph from Noah:

Graph #4: The Federal Debt Relative to GDP
It shows the Federal debt relative to a wiggly worm. According to our Graph #1 above, the wiggly worm ran low in the years before 1977, and then high till the year 2000. Running low before 1977, it makes the Federal debt look falsely high. (Low as it is in those years on Graph #4, it is falsely high.) Running high between 1977 and 2000, it makes the Federal debt look falsely low.

I'm saying that the growth of Federal debt was less than we think in the years before 1977, and more than we think in the years after. We are deceived. Why are we deceived? Because we think of the Federal debt in comparison to the wiggly path of actual GDP.

But now we can fix that. We can use the "constant growth rate" approximation of GDP in place of actual GDP. This will give us a version of Federal debt relative to GDP that is similar to Graph #4, without the distortions arising from variations in GDP growth.

Graph #5, below, shows in red the same "relative to actual GDP" data that we see on Graph #4: In particular, the red line shows the increase beginning around 1982, the increase Noah calls "the explosion in U.S. government debt".

The blue line on #5, which shows the same Federal debt but shows it relative to the "constant growth rate" approximation of GDP, shows that increase beginning around 1975. That is the same difference we noticed above, comparing Graphs #2 and #3.

The Federal debt, relative to actual GDP (red), and relative to a constant-growth approximation of GDP (blue):

Graph #5
The two lines are very similar. That says the two measures of GDP are very similar. And we would want that to be true, so we can have confidence in the approximation.

But the two lines also differ. In the years before 1977 the blue line is lower. In the years between 1977 and 2000, the blue line is higher. But look also at the transition from downtrend in the 1960s to uptrend in the 1980s. The red line (using actual GDP) hits bottom around 1974 and runs flat until 1982, and then suddenly starts on its upward journey.

We know that, of course: Noah pointed it out.

The transition from downtrend to uptrend is different for the blue line. It is earlier. Instead of going suddenly flat in 1974 like the red line, the blue line begins its uptrend there. That uptrend is definitely stronger after 1982; so if you were wanting to blame Reagan for the big increase in Federal debt I guess you can still do that. But 1982 is not where the uptrend starts. Not for the blue line. Not for the Federal debt.

And the only difference between the red and blue lines is that the red line is shaped by vagaries in both debt growth and GDP growth. The blue line is not. The blue line is the better measure of Federal debt growth.

And the postwar increase in Federal debt growth started before 1982.

//

The Excel file at Google Drive

Sunday, August 23, 2015

And you thought Milton Friedman wasn't funny!


Milton Friedman:
The price system is the mechanism that performs this task without central direction, without requiring people to speak to one another or to like one another.
- Free to Choose, Chapter One

Saturday, August 22, 2015

Oh, no. This again?


If you look at Noah's graph of debt relative to GDP, it certainly looks like the big increase started around 1982:

Graph #1: Noah's Graph

Noah's graph shows the Federal debt as a percent of GDP. I called up GDP (red) and the Federal debt (blue) as two separate series, and looked at the growth rates for those two series. Sure enough, the blue line is way up high in the 1980s:

Graph #2. Click Graph for FRED Source Page
But that's not the only thing I see. The blue line is way up high in the 1980s, and it is way down low in the 1950s and into the mid-1960s. It was low before the mid-1960s, and high after the early 1980s.

From the mid-1960s to the early 1980s, the blue line, debt growth, changes from very low to very high. Between the mid-60s and the early '80s, the growth of debt went from low to high. So it doesn't make sense to me that Noah says a deficit explosion began after the early 1980s. The explosion started in the mid-1960s and ended in the early 1980s. Noah has it wrong.

And if you look at the blue line on Graph #2, yes, debt growth reaches a high point in the early 1980s. But the trend was downhill from that moment to the year 2000.


Why does Noah's graph show increase beginning arount 1982? Why does it show the debt essentially flat all through the 1970s, while Graph #2 shows increasing debt since the mid-1960s?

Well, because Noah's graph does not show debt. It shows debt divided by GDP. That's not the same thing. Graph #2 shows the growth rates separately, so that we can better evaluate what we see on Noah's graph.

On #2 the blue line runs below the red for almost all the years before 1982. Then, the blue line runs above the red for almost all the years since 1982. So the Federal debt was growing more slowly than GDP before 1982, and faster than GDP after 1982.

This transition, this change that happened around 1982, affects the appearance of Graph #1. It pushes the debt-to-GDP ratio lower before 1982, and higher afterwards. This is one of the reasons Noah thinks he sees an "explosion" of deficits beginning in the early 1980s. There was a decrease in the growth of GDP. Noah has it wrong.

Friday, August 21, 2015

DEF: Inflation


I was going to find Milton Friedman's definition of inflation. I thought that would be a good place to go next. But before I even got started, I got email from Greg. If you leave a comment on the blog, I get it as email so I don't miss it. And Greg left a comment on the blog:

Actually Art inflation is most commonly defined as a sustained rise in the general price level over time.

So there ya go. That's pretty much word-for-word what I was attributing to Friedman. I'm still looking for that one. But meanwhile, I found this from Investopedia:

Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As inflation rises, every dollar you own buys a smaller percentage of a good or service.

The value of a dollar does not stay constant when there is inflation. The value of a dollar is observed in terms of purchasing power... When inflation goes up, there is a decline in the purchasing power of money. For example, if the inflation rate is 2% annually, then theoretically a $1 pack of gum will cost $1.02 in a year.

Okay. Except a pack of gum is still a nickel, right?

The company did not raise the original five cent price of a five-stick package of Wrigley's Spearmint, Juicy Fruit, and Doublemint gums until 1971. Management reluctantly did so by creating a seven-stick package and charging a dime for it.

Oh. Never mind. Come to think of it, I probably haven't bought gum since the 1960s.

Thursday, August 20, 2015

Four Measures of Inflation, and Five Interest Rates


The inflation measures are blue. The Interest rates are red.


The one causes the other? They move together?? They don't??? What do you see? I'll tell you what I see. I'm not nit-pickin it. Just a quick look.

On the way up, in the 1960s and 1970s, rising inflation snuck up on inflation expectations and closed the gap with interest rates. We didn't expect the inflation we were getting.

On the way down, in the 1980s and 1990s, falling inflation again surprised inflation expectations, and the gap with interest rates grew. We didn't expect the disinflation we were getting.

Doesn't say much about the relation between interest and inflation, does it?

Says a lot about expectations, though.

Wednesday, August 19, 2015

Three? Make that four


There it is. Mid-June of this year. I thought it was recent, but not that recent.

Three measures of inflation:

Graph #1: Three Measures of Inflation: CPI, the GDP Deflator, and the PCE Index

I knew about the Consumer Price Index and the GDP Deflator for a long time. I still have photocopies of Statistical Abstract tables from the early 1980s. (They cost 25 cents apiece, at the library.) But I never heard of the PCE price index till just a few years ago.

Now the other day, I read Brian Romanchuk's response to Nathan Tankus. Romanchuk writes:

Yes, economists who argue that "inflation" reduces the burden of debt are using consumer price inflation as a proxy for "generalised inflation" (which I describe below). This is technically incorrect. But as the chart below shows, there's a fairly strong correlation between CPI inflation and wage inflation, for very good reasons

What follows is most interesting. "A divergence between the two has implications for the wage and profit shares of national income," he writes. I won't quote any more of that; if you missed it you should definitely go there and read it.

So anyway, Brian Romanchuk's chart compares consumer price inflation to U.S. wage inflation. For wage inflation he uses "average hourly earnings". Something I never thought of, to be sure. But I like it.

So I picked two series out of the 267,000 FRED offers, and managed to satisfy myself that I had duplicated Romanchuk's graph:

Graph #2 (After Romanchuk) Earnings = FRED AHETPI and CPI = FRED CPILFESL
He didn't identify his data. But I got a good match by using AHETPI and CPILFESL.

Now I have four price series to look at:

Graph #3: Four Price Series
I don't usually use price series that exclude food and energy prices. To me it doesn't make sense. But that's what Romanchuk used, so I went with it for this graph.


By the way -- on that last graph, the green line runs with the low group in the 1980s, then accelerates up to the higher line and even goes above it after 2010. That line shows the fastest increase of any in the last 25 years.

That line is Average Hourly Earnings, the one I got from Romanchuk.

If you happen to be a Nathan Tankus fan (I am not) you might want to follow up on this with Brian Romanchuk. Wages are going up faster than prices? Is that with or without benefits? Either way, how can it be? Why doesn't Romanchuk point it out? and Was there no more realistic series he could have used to shoot holes in Nathan Tankus's post?

Tuesday, August 18, 2015

Less simple, but there is no reason to complicate it

Following up on yesterday's post...

Source: lancasterpollard.com
My annotations

Monday, August 17, 2015

I'm going for simple here


Source: lancasterpollard.com
My annotations

Sunday, August 16, 2015

How Changes in GDP, Inflation and Debt Influence the Erosion of Debt


I showed this graph on Saturday:

Saturday's Graph: Erosion of the Federal Debt Due to Inflation
I said I had a hard time imagining how changes in the data would be related to the changes visible on the graph. I'm back now to look at it.

I made up a spreadsheet with some made-up numbers for debt, GDP, and a price index in columns on the left. I made up 30 years of data.

TEST #1

The yellow cells are numbers I might want to change. The other cells are calculated from the yellow cells or from calculations that depend on them.

The graph is generated by the numbers in the rightmost column, the NN / RR column.

As the third row of yellow cells shows, I started with a "price index" value of 100, an initial GDP of 100, and an initial debt of 50 (half the size of GDP). The latter two numbers are somewhat arbitrary; I had to pick numbers to get started.

The initial price index value of 100 is not arbitrary. By convention or on principle or for reasons unknown, the "base year" of a price index is always given the value 100. It's probably to simplify matters. Whatever. Since I'm using 100 as my first year's price index value, you should be able to guess that I am using the first year as the base year for my calculations. Didn't have to be. But it is.

Economists tend not to do that. But I'm not an economist and I'm free to put the base year any where I want. Besides, it just makes sense. When I think about the economy, I like to set things up, start the action, and see what happens. It's just natural that where I start is the beginning.

So, the graph. Test #1, above, figures 2% inflation each year, 4% annual GDP growth -- that's nominal GDP, by the way -- and an 8% annual increase of outstanding debt.

(How that works: For inflation, I take each year's value and multiply it by 1.02 to get the next year's value. The new value turns out to be 2% bigger than the value I started with. For GDP, multiplying by 1.04 makes each new value 4% bigger than the one before. For debt, multiplying by 1.08 makes each new number 8% bigger.)

The numbers I use to set my growth rates -- 1.02, 1.04, and 1.08 -- appear in the yellow cells on the first two lines of the TEST #1 spreadsheet image. I use the numbers on the top row in the calcs for the first 15 years -- for the left half of the blue line on the graph. I use the numbers from the second row for the next 15 years, the right half of the blue line.

In TEST #1, the blue line is a nice smooth curve because the numbers on row one and the numbers on row two are the same. Now I can change one of the growth rates on the second row and maybe we'll see a kink show up right in the middle of the blue line:

TEST #2
Nope. The line looks just the same. I kept the value 1.04 (an annual growth rate of four percent) for the first 15 years, but changed the number to 1.40 for years 16 to 30. That's forty percent annual GDP growth. That's way more than China was getting. It's a ridiculous number, ridiculously big.

Still, there is no change in the blue line. No kink there in the middle. Making a huge change in the growth rate of GDP (and leaving the inflation rate and the debt growth rate unchanged) made absolutely no difference in this graph.

I thought that was pretty weird. And hey, maybe I have something wrong. It wouldn't be the first time. But I can't find it if there is. So anyway I figured let me get even more extreme with the change in GDP growth rates. So I used 0.01 for the first 15 years and then 100.0 for the next fifteen.

Still no change in the blue line:

TEST #3
In TEST #3, some of the numbers below the graph are now so big that I got nothing but cross-hatches. Hash marks I guess they're called now. Or hash tags? Whatever. But the blue line for TEST #3 looks just the same as it did for Test #1 and #2. Even the numbers in the vertical axis are the same. They run from 75 to 105 and that's it.

What this is telling me is the growth rate of GDP has no bearing on the rate of erosion of debt. I still think that's odd. And like I said, I could have mistakes in the spreadsheet. But that's what it's telling me.

So I set the GDP growth numbers back to 1.04 so the second period matches the first, so we are starting from the TEST #1 picture again. And then I increased inflation, the annual rate of inflation, from 2% to 8% on the second line. That gave me a kink in the graph:

TEST #4
For TEST #4 we have 2% inflation for the first 15 years and then 8% inflation for the next 15 years. And you can see that the blue line starts dropping faster as soon as the higher inflation rate enters the calculation.

So TEST #4 tells me that the blue line is falling because of inflation.

Remember now, the blue line is a "model" of Saturday's graph, which showed the value remaining after inflation as a percent of the total value borrowed: the value after inflation as a percent of the value at the time the money was borrowed.

So TEST #4 says 2% inflation makes debt erode slowly, and 8% inflation makes debt erode rapidly. Pretty interesting to see that on a graph, I think.

Okay. So changing the GDP growth rate has no effect, but changing the inflation rate does have an effect. What about debt? What happens if we start at TEST #1 again and then double the rate of debt growth from 8% to 16% annual?

TEST #5
Whoa! Now it looks like the Saturday graph! For the first 15 years the blue line goes down as inflation erodes debt. Then debt growth doubles, and now debt is growing so fast that the line goes up despite the 2% inflation!

The Saturday Graph Again (for comparison to TEST #5)

TEST #5 shows a much smoother line than the Saturday graph, because growth rates on the spreadsheet change once in 30 years, not every year like the real world. But you can see from these tests that inflation erodes debt, that more inflation erodes debt more, and that if debt is growing fast enough, the burden of debt increases regardless of inflation.

//

Here's a link to the Google Drive template. And the Excel XLSX file.

Saturday, August 15, 2015

GDP, the GDP deflator, Federal debt, and time



"... inflation erodes the real value of debt." - Paul Krugman


A few days ago I showed a graph of Federal debt relative to GDP. Showed the ratio of nominals, and also the ratio of reals. The two are not the same because the calculation of reals for debt differs from the calculation of reals for GDP, because debt is a stock and GDP is a flow.

This graph.

Graph #1: Ratio of Nominals (blue) and Ratio of Reals (red)
In a comment on that post, Jazzbumpa reacted:

I find the whole concept of inflation adjusting debt to be deeply troubling.

You end up with a "real" debt/GDP value that is greater than the real [i. e. currently factual] value. What does that even mean?

What does it mean? It means inflation erodes debt. The inflation-adjusted (or "real") value is greater than the inflated value because inflation erodes debt. The gap between the red and blue lines shows the extent of the erosion.

Come to think of it, we can look at the one line relative to the other. We can look at the blue line relative to the red: The inflated values as a percent of the inflation-adjusted values. On this new graph a value of 100% will indicate zero erosion of debt due to inflation. A value of 80% will indicate that 20% of the value borrowed has been lost to inflation. And 60% indicates that 40% has been lost to inflation -- or, that to pay off the debt would require only 60% of the total value borrowed.

Graph #2: The Blue Line from Graph #1 as a Percent of the Red Line from Graph #1
The only variables we're using here are GDP, the GDP deflator, Federal debt, and time. So it can only be these that influence the pattern shown on the graph.

I'm having a hard time imagining how changes in the data would be related to the changes visible on the graph. I'll have to look into that.

//

This Excel file contains the above graphs and the source data.

Friday, August 14, 2015

"... social mechanisms allowing scientists with different scientific viewpoints an opportunity to make themselves heard"


David Glasner in Romer v. Lucas:
Arrow had no answer to the question, but offered the suggestion that, out of equilibrium, agents are not price takers, but price searchers, possessing some measure of market power to set price in the transition between the old and new equilibrium. But the upshot of Arrow’s discussion was that the problem and the paradox awaited solution. Almost sixty years on, some of us are still waiting, but for Lucas and the Lucasians, there is neither problem nor paradox, because the actual price is the equilibrium price, and the equilibrium price is always the (rationally) expected price.

If the social functions of science were being efficiently discharged, this rather obvious replacement of problem solving by question begging would not have escaped effective challenge and opposition.

Thursday, August 13, 2015

Debt is built in many layers, each with its own price level


Format it like a sentence, and the title of Nathan Tankus's recent post looks like a reply to something somebody said:

No, inflation doesn’t erode the burden of debts.

His opening sentence makes his topic clear:

It is commonly argued that inflation erodes debts.

His next sentence makes his position clear:

However, the usual defenses amount to little more than circular logic.

Then he provided an example from Paul Krugman. In short:

the burden of debt has been aggravated by falling inflation

And now we know to whom Nathan Tankus was replying in his title.


Tankus explains the problem:
The source of the confusion here is that it is popular to divide key economic variables by abstract measures of the prices across the economy (such as the Consumer Price Index). This makes sense sometimes but in other situations become nonsensical. Debt is one such example.

The source of confusion, he says, is the common practice of calculating the inflation-adjusted (or "real") value of debt. The calculation, he says, divides debt by a price measure "such as the Consumer Price Index". I picked up on that right away. Not only is that calculation common. It is also wrong.

Tankus lays out the mathematical relation for us, and identifies ways the burden of debt can be reduced:
In the United States most people have debts denominated in U.S. Dollars. A useful proxy for the burden of debt is the ratio between an individual’s or sector’s nominal debt to its nominal income.

The burden of this debt falls when they can refinance at a lower nominal interest rate, their nominal income rises or they default.

It's not just a proxy. I'd call the debt-to-income ratio a way to actually measure the burden of debt. But Nathan Tankus and I are in the same ballpark.

His next sentence I'm not sure about:
In most discussions the “real value of the debt” is discussed while still talking about nominal income (or at least being unclear about the measurement of income).

Could be. I've seen people divide a nominal quantity by an inflation-adjusted quantity and use it as evidence that labor costs drive inflation. I've seen Milton Friedman divide a nominal quantity by an inflation-adjusted quantity and draw the conclusion that printing money is the cause of inflation.

That's the way that calculation works: Whatever nominal thing you divide by an inflation-adjusted quantity, you can make a specious argument that your nominal thing is the cause of inflation. So I am highly sympathetic when Tankus says he doesn't trust ratios that use both "real" and "nominal" values.

Then he says
It is basic math that dealing with such a ratio you have to divide the numerator and the denominator from the price level to stay consistent. However, from that point of view it becomes clear the exercise is nonsense.

After that he loses me. In the next sentence following the word "nonsense" Nathan is suddenly talking of "falling productivity" and "oil". So instead of reading more, I went back to the part that made sense. I agree when he says you have to divide both the numerator and the denominator by the price level to be consistent. Yes. Otherwise you're just factoring the price level into your results.

But Nathan says it is okay to use the "consistent" calculation with debt. I disagree. Debt is almost always an accumulation of multiple borrowings from multiple years. The consistent calculation divides each year's debt number by only one year's price level. There is no thought given to multiple-year accumulations of debt.

My debt today includes money I borrowed last year to buy a car, and money I borrowed several years back when I bought a house. To figure my "real" debt correctly I would have to divide part of my debt by last year's price level and part of it by the price level when I bought the house. The common calculation does not do that, not even the "consistent" version. The common calc divides this year's total outstanding debt by this year's price level. It divides last year's total outstanding debt by last year's price level. It divides any one year's total outstanding debt number by that year's price level. There is no allowance for multi-year accumulations of debt. The common calculation converts from any one year, to a "base" year, and that's it.

In addition to the problem of dividing nominals by reals, which Nathan Tankus points out, there is the problem that the common calculation does not allow for multiple-year accumulations. In plain English, when you use the common calculation to inflation-adjust debt, you get the wrong answer.

Wednesday, August 12, 2015

Ceteris paribus


Descartes:

...the man who is wont to attend to many things at the same time by means of a single act of thought is confused in mind.... people who do not allow their thought to be distracted by various objects at the same time, but always concentrate it in attending to the simplest and easiest particulars, are clear-headed.

Tuesday, August 11, 2015

The Inflation Adjustment of Debt

A partial re-post from 4 August. In response to Nathan Tankus.

//

Let me take the Federal debt numbers, as Noah does, and look at them a little more carefully than he does. I want to look at the year-to-year change in the Federal debt. I want to look at each year's increase. That's like looking at the deficits, just as Noah wanted.

I want to remove the inflation from each year's deficit, and then add up all the deficits to see the inflation-adjusted debt. This is a necessary step, as Noah's "explosion" occurs just as the Great Inflation is coming to an end. How can we know whether the explosion Noah sees was the result of policy or an accident of inflationary numbers?

We have to look.

Graph #5: Noah's Numbers (blue) and My Numbers (red)
The blue line on Graph #5 shows a sudden increase beginning in the early 1980s, just as Noah Smith showed. The red line shows the increase beginning around 1974, after a decline that ends around 1966. Does it matter? It might. It wouldn't be right to say the U.S. federal deficit "began to trend upward beginning around 1980".

"Real" numbers provide the better measure of growth. If you are looking at the growth of deficits, "explosive" or otherwise, you want to use the red line. Not the blue line.

//

Most people will tell you that the red line should be identical to the blue line because a ratio of reals comes out the same as a ratio of nominals.

It depends how you do the math. Here's how I did the math:

1. Take the annual change in Gross Federal Debt (FRED's FYGFD) as a measure of Federal deficits.
2. Convert these deficit numbers to "real" deficits: Divide each year's deficit by that same year's GDP Deflator, and multiply the result by the Deflator value for 1947.
3. Calculate the "real" Federal debt: Start with the FYGFD value for 1947 and add to it the "real" deficit numbers for 1948-2013 as calculated in Step 2.
4. Calculate "real" GDP for Base Year 1947 by following the same method I used to calculate real deficits.
5. Plot real debt as a percent of real GDP, and nominal debt as a percent of nominal GDP.

The trick is to figure each year's inflation for that year's deficit.

You can download the Excel file fredgraph(1yWX) from Google Drive.

My source data is from this FRED graph.

Monday, August 10, 2015

Full circle


Okay. I went back to Wolfgang Streeck's post, the one we looked at yesterday: How Will Capitalism End?. I was looking at his graphs, Figures 5 and 6. Total tax revenue as a percent of GDP... and Top marginal income tax rates. Went to FRED and came up with this, which I thought was interesting:

Graph #1, from FRED: The Tithe

Then I Googled tax rate historical graph to find something relevant to my FRED graph. Found this one:

Graph #2 from Ritholtz via the Hipcrime Vocab

The Google Image "visit page" button brought me to the Hipcrime Vocab. Interesting site. Funny thing is, Hipcrime's three most recent posts bring us right back to Wolfgang Streeck's topic.

Sunday, August 9, 2015

"How Will Capitalism End?"


Via Reddit, from the New Left Review: How Will Capitalism End? by Wolfgang Streeck. A long article; you can download the PDF but it is 30 pages, a number that exceeds my brain capacity...

So far I read almost the whole first paragraph,
There is a widespread sense today that capitalism is in critical condition, more so than at any time since the end of the Second World War. Looking back, the crash of 2008 was only the latest in a long sequence of political and economic disorders that began with the end of postwar prosperity in the mid-1970s. Successive crises have proved to be ever more severe, spreading more widely and rapidly through an increasingly interconnected global economy. Global inflation in the 1970s was followed by rising public debt in the 1980s, and fiscal consolidation in the 1990s was accompanied by a steep increase in private-sector indebtedness. For four decades now, disequilibrium has more or less been the normal condition of the ‘advanced’ industrial world, at both the national and the global levels.
(Footnotes removed.)

and looked at the first graph:


Like you perhaps, I was drawn to the article by its title. And then, that first paragraph was most satisfying: Capitalism IS in critical condition. The crash of 2008 WAS the latest in a long sequence of disorders that began in the mid-1970s. Successive crises HAVE proved to be ever more severe.

I like the quote because it identifies monetary problems: inflation in the 1970s, public debt in the 1980s, and private debt in the 1990s. Excellent focus. Then I react: Hey, I'm one paragraph into a 30-page paper, I know, but I think Wolfgang Streeck is gonna go off in some weird direction and I'm probably going to have to disagree with him.

So I have to write this before I read any more.

//

The end of capitalism? Where does he get that?

Oh -- I know where he gets it. I read about this. Time magazine 31 December 1965 maybe, Leuchtenburg maybe, and Toynbee, lots of Toynbee. I read about this.

William E. Leuchtenburg in Franklin D. Roosevelt and the New Deal, from Chapter 2:
The longer the depression persisted, the more people began to conjecture whether they were not witnessing the death of an era. "One wonders if this paralysis of the power to produce and consume will drive us all to a life on the level of the Middle Ages," speculated a welfare worker.... A writer asked: "Will future scholars date from 1929 the decline and fall of western civilization, as we now hear on every hand ... ?"

Many believed that the long era of economic growth in the western world had come to an end.

Sheesh. Let a time of troubles arise, and suddenly everyone thinks it's the end of life as we know it. You know what I have to say to that? Stop making predictions. Just stop.

Yes, things went sour in the 1970s -- or the 1960s, I'd say -- and got worse since then, and now things are extremely bad. The quote is valuable because it points out that the problem started long ago and has been getting worse. A lot of people don't seem to realize it.

Streeck's word "critical" implies the end is near. We don't know that. It's a prediction. Still, things have been getting worse for so long now that we don't need to predict the future. It is enough to consider the last fifty years.


"The End Is Near"


Where does this idea come from, that endings are at hand? When things go bad for a long time, when things get bad enough, our natural optimism succumbs to a more practical view. Keynes had it right when he said:
In practice we have tacitly agreed, as a rule, to fall back on what is, in truth, a convention. The essence of this convention — though it does not, of course, work out quite so simply — lies in assuming that the existing state of affairs will continue indefinitely, except in so far as we have specific reasons to expect a change.

After things have been going bad for a while, we start accepting the downhill trend as the new normal. All we can see at the end of the trend is the end of life as we know it.

I'm thinking that's where the idea comes from.

//

How does it work? Arnold J. Toynbee described the progress of civilizations as a repeating pattern. He called it "challenge and response":
Now civilizations, I believe, come to birth and proceed to grow by successfully responding to successive challenges. They break down and go to pieces if and when a challenge confronts them which they fail to meet.

In the Somervell abridgement of A Study of History, Toynbee described what happens when the response is not successful:
When the outcome of each successive encounter is not victory but defeat, the unanswered challenge can never be disposed of, and is bound to present itself again and again until it either receives some tardy and imperfect answer or else brings about the destruction of the society which has shown itself inveterately incapable of responding to it effectively.

This is exactly our situation today -- and for the past 50 years. Many people have been convinced by the long duration of the decline, that the end is near. Indeed, it could be. But all we need to prevent it is the right response to the challenge.

//

The economy was good, before the mid-1960s. On the last day of 1965, Time magazine put John Maynard Keynes on the cover, and included these words in the opening paragraph of their cover story:
In Washington the men who formulate the nation's economic policies have used Keynesian principles not only to avoid the violent cycles of prewar days but to produce a phenomenal economic growth and to achieve remarkably stable prices. In 1965 they skillfully applied Keynes's ideas—together with a number of their own invention—to lift the nation through the fifth, and best, consecutive year of the most sizable, prolonged and widely distributed prosperity in history.

They ended that article with these words:
If the nation has economic problems, they are the problems of high employment, high growth and high hopes. As the U.S. enters what shapes up as the sixth straight year of expansion, its economic strategists confess rather cheerily that they have just about reached the outer limits of economic knowledge. They have proved that they can prod, goad and inspire a rich and free nation to climb to nearly full employment and unprecedented prosperity. The job of maintaining expansion without inflation will require not only their present skills but new ones as well. Perhaps the U.S. needs another, more modern Keynes to grapple with the growing pains, a specialist in keeping economies at a healthy high. But even if he comes along, he will have to build on what he learned from John Maynard Keynes.

I always wanted to be that guy.

//

It was a golden age. But they did mention "the job of maintaining expansion without inflation". That one turned out to be a killer.

The Kennedy half dollar issued in 1964 contains $5.38 worth of silver at recent prices. But at those same prices, the Kennedy half issued in 1965 contains only $2.20 in silver. Because after 1964 the silver content dropped.

In 1964 the silver content in those coins was 90%. For 1965 it was reduced to 40%. They knew already in 1964 -- before they had minted any coins for 1965 -- they knew that inflation was forcing debasement of the coinage. That's a significant point in the history of the U.S. economy. They knew it a good two years before that December 31, 1965 issue of Time came out. At least two years.

Time was aware, too. They wrote of "maintaining expansion without inflation".

1965 -- That was the start of the Great Inflation, according to Alan Meltzer. And, as "Adam Smith" wrote in Paper Money,

That was the high point. The dragons of inflation and unemployment began to snort in their caves, and 'stagflation,' an awkward beast, a hybrid of inflation and stagnation, roamed without serious natural enemies. Cynics said there were two sure signs that the Keynesian era was waning. One was that Time magazine put Keynes on its cover....

//

What I get from Toynbee:

When the outcome of each successive encounter is not victory but defeat, the unanswered challenge can never be disposed of, and is bound to present itself again and again until it brings about the destruction of the society which has shown itself incapable of responding effectively.

The roots of our economic problem go many years back, and many people now fear the end is near. But I am reminded of Thomas Edison, inventing the light bulb. Forbes:

For example, in developing a commercially viable light bulb, Edison actually went through over ten thousand prototypes before getting it right... Later Edison became famous for saying “I have not failed 10,000 times. I have not failed once. I have succeeded in proving that those 10,000 ways will not work. When I have eliminated the ways that will not work, I will find the way that will work.”

Edison, and Sherlock Holmes:

How often have I said to you that when you have eliminated the impossible, whatever remains, however improbable, must be the truth?

None of the things we've tried have solved the economic problem. We need to admit that our solutions have not worked, and find something else to try. Eliminate the ways that have not worked, and consider what remains.

Our task is to improve our understanding of the economic problem until solutions become obvious.

And do it before time runs out.


"Keynes did not despair of capitalism as so many other economists did." -- Time

Saturday, August 8, 2015

Trying to describe what the problem is


A vague recollection of something Paul Krugman said led me to a CEPR post from January of 2014:
Paul Krugman is a very smart person who does a fine job of defending himself. But he has enough detractors who repeat the same nonsense enough times that some reasonable people may actually be deceived.

For this reason, I will briefly intervene to point out that the people claiming Krugman called on Greenspan to create a housing bubble in 2002, like Bret Stephens in the Wall Street Journal today, are just making stuff up.

The basis for this absurd claim was a 2002 column on the weak recovery following the 2001 recession. The column notes the weakness of the economy at the time (we were still losing jobs 8 months after the official end of the recession) and attributes it to the fact that the 2001 recession was not a standard post-war recession. It was brought about by the collapse of the stock bubble.

Krugman then wrote:

"To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble."

It should have been pretty evident that this was sarcastic ...

I wouldn't say Krugman was being sarcastic. I think he was trying to describe what the problem is: We don't get growth these days unless we get a bubble. It's a pretty straightforward observation on his part. It wasn't even his observation, actually. It was McCulley's.

The reason this comes up is that I said something similar a while back, and just came upon it now. In Reduction (3) I quoted me:

The problem is not that we have inflation. The problem is not that economic growth is weak. The problem is that we need an inflationary increase in the money in order to get decent growth. Since we have chosen to keep inflation at a low level, we are limited to a low level of economic growth. This problem cannot be solved by thinking of inflation and growth as two separate problems.

I still use the word "inflation" as though I was still in the 1970s. Forget about that. If you take what I said and change the word "inflation" to "bubble" you get pretty much exactly what Paul Krugman said:

The problem is not that we have bubbles. The problem is not that economic growth is weak. The problem is that we need a bubble in order to get decent growth.

A bubble, of course, is inflation: asset inflation that ends in a crash. So Krugman and I are not very far apart on this. And because economy-wide inflation has been quashed by policy since Carter appointed Volcker, the only way inflation can really get rolling is in the form of a bubble.

Friday, August 7, 2015

The worst advertising campaign in history


Value is in the eye of the beholder. Value is subjective. What's valuable to me may not be valuable to you.

Define value:


Define economic utility:


Value is like utility. Utility is how useful a thing is to me (or to you or to us or to them). I like to think of "value" as the ratio of usefulness-to-cost. The more useful a thing is, compared to its cost, the better the value. The more costly it is, compared to its usefulness, the worse the value. I think that's intuitive, but maybe people don't generally put it into words.

So what does it mean when GMC and Chevy run ads like this:


The MSRP is $44,000 plus. They'll give me 6 grand off the price. So they'll sell it to me for 38 grand. But they're telling me the car has a "total value" of $6000.

Why would I pay $38,000 for a car that's worth $6000? This must be the worst advertising campaign in history.

Thursday, August 6, 2015

Filler


Like Billy, the Archdruid is reliably long-winded. So when I see his recent post is titled The Suicide of the American Left, I'm confident I can pick out a cherry or two and end up with something tasty.

An ever more intrusive and metastatic bureaucratic state funneling trillions to corrupt corporate interests, an economic policy made up primarily of dishonest statistics and money-printing operations, and a monomaniacally interventionist foreign policy: that’s the bipartisan political consensus in Washington DC these days ...

"An economic policy made up primarily of dishonest statistics and money-printing operations". I like that.

And this is good:
The one thing that can reliably bring a nation through a time of troubles of the sort we’re facing is a vision of a different future, one that appeals to enough people to inspire them to unite their energies with those of the nation’s official leadership, and put up with the difficulties of the transition. That’s what got the United States through its three previous existential crises: the Revolutionary War, the Civil War, and the Great Depression. In each case, when an insupportable status quo finally shattered, enough of the nation united around a charismatic leader, and a vision of a future that was different from the present, to pull some semblance of a national community through the chaos.

We don’t have such a vision in American politics now. To an astonishing degree, in fact, American culture has lost the ability to imagine any future that isn’t simply an endless rehash of the present—other, that is, than the perennially popular fantasy of apocalyptic annihilation, with or without the salvation of a privileged minority via Rapture, Singularity, or what have you. That’s a remarkable change for a society that not so long ago was brimming with visionary tomorrows that differed radically from the existing order of things.

I quit reading, right there. I got what I needed. I would say only that we don't really need a vision, unless by "vision" you mean the ability to see the real economic problem and have a plan to solve that particular problem.

Wednesday, August 5, 2015

Real GDP (base year 1947) and Nominal GDP



Tuesday, August 4, 2015

Better Measure


To figure the "real" (inflation-adjusted) values for a data series like GDP is a two-step process:

1. Divide the series by a price series like the GDP Deflator to remove the inflation; and
2. Multiply by 100 to express the numbers as dollars from the year 2009.

Graph #1: The GDP Deflator (Base Year 2009)
If we multiply by 12.886 instead of by 100, we can express the numbers as dollars from the year 1947.

//

Inflation makes prices go up.

If we use a price series with a base year of 2009 and prices go up, a graph of the years after 2009 will show that inflating prices are higher than stable prices. Sure, we knew that already. (But at least the graph will show something that makes sense.)

If there was inflation in the years before the base year, the graph will show the inflating prices lower than stable prices. I know that's true. But it bothers me, because inflation makes prices go up. You have to think about it like you're going backward in time, to watch inflation push prices down in the years before 2009. It's more like science fiction than economics.

//

The simplest way I can think of, to eliminate the conundrum of inflation pushing prices down in the years before the base year, is to move the base year back in time. I did it the other day with 1958. I'm going to do it now with 1947, the first year on the graph that I'll be showing you. So there won't be any years before the base year, and when there is inflation it will make prices go up. Just like in the real world.

On Graph #2, the blue line shows GDP, replete with inflation. The red line shows GDP at stable 2009 prices. The green line shows GDP at stable 1947 prices. The calculations are as described above.

Graph #2: Nominal GDP (blue) and Real GDP, 2009 base (red) and 1947 base (green)

The red and blue is how economists like to show inflation. The green and blue is a more honest picture.

//

I keep going back to Noah Smith's claim that government deficits "exploded" in the early 1980s. Exploded, meaning they suddenly increased a lot. Noah didn't investigate the claim. He just repeated it, then tried to explain why it happened.

But it didn't happen. That's my claim. And I propose to prove my point once again, here and now. Let me begin with the opening of Noah's post:

The U.S. federal deficit, which had been decreasing since the end of WW2, began to trend upward beginning around 1980:


You can see on Noah's graph, the blue line comes down slowly until 1980 or '81, then takes off uphill at a rapid clip. Just as Noah says.

Unfortunately, the blue line does not represent the U.S. Federal deficit. It represents the Federal debt -- the accumulation of deficits -- relative to GDP. You cannot just glance at the graph and see evidence of deficits exploding after 1981. The graph does not show deficits.

"Relative to GDP" is a reasonable context. That's what Noah used for his graph, and I have no problem with that. But GDP was severely affected by inflation between 1965 and the early 1980s. After that, the Great Inflation suddenly became disinflation. GDP growth, nominal GDP growth, underwent a sudden slowdown.

Graph #4: Inflation fell precipitously in the early 1980s
Inflation fell precipitously in the early 1980s. So the increase of GDP was suddenly much slower than it had been since the mid-1960s. Anything that did not slow precipitously in the early 1980s -- the Federal deficits, perhaps -- would appear to show an "explosive" increase when compared to GDP. That increase, at least in part, is an illusion.

I'm not saying the Federal deficits didn't increase. I'm not saying they didn't increase a lot. I am saying they didn't increase as much as you might think, and the increase didn't start when you might think.

I'm just asking you to reserve judgement till I've made my case.

//

Let me take the Federal debt numbers, as Noah does, and look at them a little more carefully than he does. I want to look at the year-to-year change in the Federal debt. I want to look at each year's increase. That's like looking at the deficits, just as Noah wanted.

I want to remove the inflation from each year's deficit, and then add up all the deficits to see the inflation-adjusted debt. This is a necessary step, as Noah's "explosion" occurs just as the Great Inflation is coming to an end. How can we know whether the explosion Noah sees was the result of policy or an accident of inflationary numbers?

We have to look.

Graph #5: Noah's Numbers (blue) and My Numbers (red)
The blue line on Graph #5 shows a sudden increase beginning in the early 1980s, just as Noah Smith showed. The red line shows the increase beginning around 1974, after a decline that ends around 1966. Does it matter? It might. It wouldn't be right to say the U.S. federal deficit "began to trend upward beginning around 1980".

"Real" numbers provide the better measure of growth. If you are looking at the growth of deficits, "explosive" or otherwise, you want to use the red line. Not the blue line.

//

Most people will tell you that the red line should be identical to the blue line because a ratio of reals comes out the same as a ratio of nominals.

It depends how you do the math. Here's how I did the math:

1. Take the annual change in Gross Federal Debt (FRED's FYGFD) as a measure of Federal deficits.
2. Convert these deficit numbers to "real" deficits: Divide each year's deficit by that same year's GDP Deflator, and multiply the result by the Deflator value for 1947.
3. Calculate the "real" Federal debt: Start with the FYGFD value for 1947 and add to it the "real" deficit numbers for 1948-2013 as calculated in Step 2.
4. Calculate "real" GDP for Base Year 1947 by following the same method I used to calculate real deficits.
5. Plot real debt as a percent of real GDP, and nominal debt as a percent of nominal GDP.

The trick is to figure each year's inflation for that year's deficit.

You can download the Excel file fredgraph(1yWX) from Google Drive.

My source data is from this FRED graph.