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tions of eyes and hair can be seen in the graph next i want to graph the raw debt numbers not divided by gdp along with real debt numbers figured the way real gdp is figured graph 3 the raw numbers and real debt figured by aggregate debt adjustment the relation between the two lines shown on graph 3 is similar to the relation between nominal gdp and real gdp which you have probably seen many times the two lines cross in 2005 because the price deflator used for the conversion has 2005 as its base year the red line is higher than the blue in the years before 2005 and the blue line is higher in the years after 2005 suppose you wanted to use this graph to learn something about inflation s ability to erode debt after all some people do call for a higher inflation target increased inflation to help reduce the burden of debt but in 2005 the lines cross the real and nominal values are equal in 2005 in other words in 2005 there was no erosion of debt despite all the inflation we had between 1950 and 2005 that is wrong of course but that is what the graph shows it is the calculation used to figure real debt that is incorrect next i want to do the graph again using the incremental inflation adjustment described in yesterday s post graph 4 the raw numbers and real debt figured by incremental debt adjustment here real debt is significantly higher than nominal debt at every point on the graph the red line is higher than the blue by the amount that debt was eroded by inflation if you are looking to see the erosion of debt this graph shows it incremental data adjustment ida of debt shows it the google docs spreadsheet posted by the arthurian at 4 00 am 6 comments labels erosion of debt wednesday august 15 2012 on erosion 1 calculating real debt the typical inflation adjustment of gdp takes the total dollar value of one year s output and converts it to the dollar value for another year to do this is fairly simple divide the one year s price number out of the gdp and multiply the other year s price into it for example if a basket of goods used to cost 80 but now costs 125 take gdp now divide by the current price number and multiply by the old price number this calculation is used all the time to figure what economists call real gdp but what happens when you want to figure debt as real debt consider any particular year the new debt created that year should be adjusted the same way gdp is adjusted for that year divide it by the price level for that year and multiply by the base year price but when we inflation adjust debt we often get the wrong answer the problem is that the total debt number for any one year includes both the new debt from that year plus a lot of old debt left over from other years the current year s price number is relevant only for the current year s addition to debt for older debt included in the current balance you have to use price numbers from prior years one good technique is to separate the new debt from the old debt then you inflation adjust the new debt for the year just the same way you would inflation adjust the gdp for that year next you look at the old debt that you didn t adjust yet pull out just the most recent year s debt remaining in it and inflation adjust that year s debt using that year s price number and you keep doing that stepping back a year and adjusting just the one year s debt the same way you would figure real gdp for that year then stepping back another year you go back as far as you can go adjusting each year s debt separately and then add them up this method may be thought of as incremental adjustment of debt i don t mean to harp on it but it seems most people think you can adjust debt for inflation the same way you adjust gdp for inflation you cannot it works for gdp because gdp is a measure of one year s stuff it doesn t work for debt because any year s debt is almost always an accumulation of many years deficits recently krugman and sumner and nunes and wojnilower and yours truly considered this graph from paul krugman krugman sees a dramatic rise in household debt which many of us now believe lies at the heart of our continuing depression sumner says i suppose it s in the eye of the beholder but i see three big debt surges 1952 64 1984 91 and 2000 08 nunes writes why does the share of debt rise i believe it reflects peoples optimism about future prospects during the 1950s and first half of the 1960s we observe a rise in household debt people felt good about the future note however that as soon as inflation begins to trend up in the second half of the 60s the future doesn t look so bright anymore households don t increase indebtedness and when sumner reports that the first two debt surges were followed by golden ages and the third by a severe recession and asks what was different with the third case joshua wojnilower responds the difference is the aggregate amount of household debt compared with incomes as the aggregate amount of debt rises an increasing percentage of income and savings becomes necessary to cover interest costs and pay back previous debt these actions reduce the amount of income and savings available for consumption and investment creating a drag on economic growth wojnilower doesn t read anything into the graph he doesn t chop it up into surges and remissions the way sumner does he doesn t attribute the surges to optimism the way nunes does he doesn t even describe the increase as dramatic the way krugman does wojnilower says only that debt was very high by the end then he lays out a scenario explaining some troubles that may arise when debt gets very high by contrast sumner presents a relaxed eye of the beholder evaluation of the graph he points out three big debt surges and the remissions of debt growth following each and yes if you glance at the graph you can see the surges clearly but sumner s evaluation of the graph is too relaxed and he misses an important detail he calls the end of the first surge at 1964 and the start of the second at 1984 as luck would have it allan meltzer calls the start of the great inflation at 1965 and its end at 1984 the great inflation fits very neatly between the first two of sumner s surges could sumner have missed it with all the ruckus these days calling for policymakers to raise the inflation target from 2 to 4 or more simply to help erode debt i don t see how sumner could possibly have overlooked the great inflation the great inflation significantly reduced the burden of debt relative to gdp and that is what you see between sumner s first and second surge on krugman s graph perhaps sumner would say that the inflation in the numerator cmdebt and in the denominator gdp of krugman s ratio simply cancel each other out but if that was true there could be no such thing as the erosion of debt by inflation related post microbes posted by the arthurian at 4 00 am 7 comments labels erosion of debt tuesday august 14 2012 the problem is not the dual mandate reviewing an old article from cnn money republicans to fed forget about jobs by annalyn censky 3 december 2010 for more than 30 years the fed has been tasked with a so called dual mandate which outlines two important goals keep prices stable and maximize u s employment but some critics are sick and tired of the fed prioritizing job creation at the risk of rising prices they say the juggling act of promoting economic growth while staving off inflation has proven ineffective and has led to a policy of too much cheap money with dangerous consequences for the economy a house bill introduced last month by pence seeks to scale the dual mandate back to a single goal of focusing only on prices and leave job creation policy up to congress you know congress never keeps its hands off job creation policy they re always spending more to stimulate the economy or spending less to let the private sector blossom it s all hokum and hogwash anyway pence is focused on the wrong thing he has not identified the problem he has identified a problem but if you re not fixing the problem then you are just trying to fix results and that ll never work the problem is excessive debt here s what congress does to grow the economy they cut taxes assuming that people will spend more as a result they encourage saving so that we may borrow more and spend it they encourage spending by means of the business tax code to grow the economy congress does all sorts of things to cause spending to increase here s what the fed does they fiddle with interest rates and the quantity of money in order to control inflation they limit the amount of money that is in the economy think of it like in the 1800s when we used gold for money the fed is limiting the amount of gold we have to spend while congress busies itself doing things to make us spend more more spending less money so we use credit so our financial costs increase so eventually the money that circulates outside the financial sector becomes insufficient to support both the productive sector and the financial sector that s when you get a crisis so what the hell is pence talking about posted by the arthurian at 4 00 am 0 comments monday august 13 2012 when finance grows large it circumvents and weakens policy note well the title of this post it is not just a point of view it is a view about the survival of societies it is a view compatible with arnold toynbee s statement that civilizations die by suicide posted by the arthurian at 4 00 am 0 comments sunday august 12 2012 prioritizing in a comment on scott sumner s debt surges don t cause recessions sumner wrote woj you said as the aggregate amount of debt and interest rises the percentage of income used to pay interest costs or pay down debt also rises lowering the amount available for consumption investment this is simply factually wrong every debt payment is money received by someone else let s put it a little differently then let s stop confusing the financial sector with the productive sector let s look at them like two different sectors of the economy you know the same way the stats are presented all the time as the aggregate amount of debt and interest rises the percentage of productive sector income used to pay interest costs and pay down debt also rises lowering the amount available for consumption and investment in the productive sector it does not matter that every debt payment is money received by someone else it would not matter even if every debt payment was received by the same person who made the payment what matters is that the money is moving out of the productive sector and into finance that is the problem among economists mind you productivity is said to be of the highest importance i go back again and again to adam smith and his factors of production though i do not think he called them that smith looked at the component parts of the price of commodities he thought the topic important enough not only to write about but to use in the title of the chapter where he wrote it modern economists or textbook writers at least seem to think the factors of production are all about the inputs to the production process that is incorrect or if not incorrect it is of no importance whatsoever to macroeconomics why economics seems boring economists insist on talking about inconsequential and meaningless things in place of math anxiety there is economics ennui the issue is the component parts of price the issue gentlemen is cost as the aggregate amount of debt and interest increases the cost of finance rises in the productive sector as smith put it the interest of money is always a derivative revenue which if it is not paid from the profit which is made by the use of the money must be paid from some other source of revenue the cost of finance if not paid out of profit comes out of wages now who ya gonna listen to sumner or smith posted by the arthurian at 12 00 pm 3 comments labels factors beating the dead horse again we looked at household debt the other day relative to gdp that s krugman s graph used by sumner and nunes and me sumner foolishly said it shows one debt surge ending in 1964 and another starting in 1984 i say that between 1964 and 1984 the great inflation pushed the denominator up and flattened the curve let us look at that let s us separate out cmdebt and gdp as two separate lines and compare their growth rates graph 2 growth rates of household debt blue and gdp red click for fred source page at the very start the red line is high but the blue line didn t even start yet and at the end the red line is higher than the blue but the blue line is down because of the crisis other than that there are only four times that the red line is clearly above the blue line around 1965 and 1969 and again around 1975 and 1981 that s it for those four brief moments gdp grew faster than household debt all four of those moments are within the period called the great inflation in all four cases gdp grew faster than household debt because inflation drove prices up so the dollar value of gdp went up it was not so much that output increased but the rising price of output pushed the red line above the blue at all other times with inflation more moderate gdp growth ran lower than the growth of household debt oh oh oh there is something else after the 1990 recession the red line rose briefly above the blue and again ever so slightly maybe around 1998 but you know what those two glaring highs of gdp growth both fall within sumner s second golden age 1991 2007 so again it isn t necessarily that debt growth slowed but that actual improved real growth gives the impression of slower debt growth posted by the arthurian at 4 00 am 3 comments saturday august 11 2012 how can i resist two from cochrane i quoted him here tax consumption not savings and i quoted him here most economic analyses don t look at the long run growth effects of tax distortions yep like taxing consumption but not savings i refer you to my recent remarks on savings posted by the arthurian at 4 00 am 3 comments friday august 10 2012 doubting lars in a look at cochrane s inconsistencies lars christensen writes cochrane seems to be very upset about the calls for easier monetary policy in the euro zone here is cochrane as you might have guessed i think it s a terrible idea hence cochrane thinks easier monetary policy is very evil however in the in the comment section cochrane states the following i like a price level target i view money as a set of units for value and i don t think the government artfully devaluing the meter and kilo to give shopkeepers a boost is a good idea any more than fooling with inflation to do so even if it does work at least once anyway note that cochrane says he likes a price level targeting regime fine with me then why not endorse price level targeting for the euro zone professor cochrane the graph below shows the euro zone gdp deflator and a 2 trend path for prices the 2 path is of course what the ecb would be targeting if it implemented a price level...