There’s a now famous graph showing the big drop in American NGDP, relative to trend, after mid-2008.  The slowdown was even more severe in Europe.  I’ve often pointed to Australia as a country that avoided this dramatic NGDP growth decline.  But commenter Declan pointed out that it sure looks like Australian NGDP crashed much like American NGDP, at least on the graph he sent me:

So was I wrong?  Maybe, but I’m not convinced, and I’d like to know what you think.  My theory is that people have their eye drawn toward trend lines that may not be real.  Suppose we drew that red line slightly lower, so that 2008 was a boom period well above trend, and 2012 was back on trend.

So I did some computations, and here’s what I noticed:

Australian NGDP growth from 1996:2 to 2006:2 averaged 6.54%

Australian NGDP growth from 2006:2 to 2012:2 averaged 6.49%

Those both round off to 6.5%.  That sure looks like “level targeting.”  So what’s going on here, and why does the graph look so different?

I picked 2006:2 because that’s when Australia’s big commodity boom seemed to begin rapidly boosting NGDP.  It grew at a 9.65% annual rate over the next 9 quarters, pushing NGDP well above the 1996-2012 trend line.  Then the commodity prices fell sharply in the 2009 recession, and Australia’s NGDP actually declined a tad.  Normally that would have produced a recession, but the decline was from such a peak of prosperity that it merely led to a sluggish period of slightly elevated unemployment.  At least that’s what I think happened.

In contrast:

US NGDP growth from 1996:2 to 2006:2 averaged 5.5%

US NGDP growth from 2006:2 to 2012:2 averaged 2.6%

However, for the US the period around 2006:2 was probably near our peak, so I generally use mid-2008 as a benchmark; when unemployment was closer to the mid-5% range, i.e. closer to the natural rate.  But the slowdown still looks very sharp.

US NGDP growth from 1996:2 to 2008:2 averaged 5.25%

US NGDP growth from 2008:2 to 2012:2 averaged 1.97%

And I think the slowdown in the US would look sharp for any plausible “before and after.”

There is probably a bit of serendipity in the Australian numbers, and given the volatility caused by commodities, as well as the probable global “Great Stagnation” now beginning, I’m not predicting Australia will keep growing at 6.5%—I’d expect somewhat slower growth going forward.

I’d welcome suggestions from commenters, and have an open mind on how to draw trend lines.  But keep in mind that it’s easy to be fooled into thinking it’s “obvious” where the trend line should be, when it’s not at all obvious.  When someone adds a trend line to a chart, they are subtly biasing the way you look at that chart; the way you interpret the data.  I can draw a line to make it look like there was a big boom, or a big recession, depending on how high up I draw the trend line.  You might think some sort of “least squares” approach is objective, but it’s not—as you still need to decide which years to include.  I’m pretty sure Tyler Cowen would say even mid-2008 was above trend, in retrospect.

And of course trends change over time when central banks are not doing NGDPLT, which makes things even trickier.  Even the “Great Moderation” in the US saw a subtle drop in the trend line from the 1980s to the 1990s.

Last weekend I had granite countertops installed in my kitchen.  The old Formica counters that I had installed back in 1997 were warped near the stove, water damaged near the sink, rusty, peeling, etc.  I never realized how materialistic I was until I saw those sleek dark granite slabs.  It almost makes washing dishes enjoyable.  Now I like to just stand and look at the counters, run my hands over the surface.  Like those cavemen in “2001,” examining the sentinel.

Augustus said; “I found Rome a city of bricks, and left it a city of marble.”  (He didn’t know that marble absorbs stains.)

I grew up in a Formica America, and will die in a granite America.  When younger economists claim that the real median income in American is no higher than in 1970 I just shake my head.  I’m old enough to remember what America was like in 1970.

PS.  When I retire I hope I can say; “I began working in a profession obsessed with inflation, and retired from a profession obsessed with NGDP growth.”  Yes, delusions of grandeur, but at least I’m not expecting a month to be named after me.

PPS.  Don’t know if they have Formica in other countries—it’s a sort of plastic laminate.

PPPS.  My house is brick, not marble.

PPPPS.  Yes, granite is very durable, which makes it investment . . .

. . . and of course saving too!

A recent comment section exposed a number of fallacies about saving:

1.  One fallacy is that one can prove a definition wrong by pointing to facts about the economy.  This is not correct.  Textbooks define saving as being equal to investment, i.e. saving is the funds used for investment.  Indeed this is part of another textbook definition, gross domestic income (C + S) equals gross domestic product (C+I).  One may not like those definitions, but pointing to real world examples to disprove them just won’t work.  Thus if someone says: “Suppose I put money in the bank, and the bank doesn’t invest the money,” it just makes my eyes glaze over.  I know immediately that I’ll disagree with your characterization about what’s happened to either S or I.  There is no debate about whether tautologies are correct, just about whether they are useful. If instead you say: “Here’s why I think a different definition would be more useful, more enlightening,” then my eyes will light up.   That is, until you start talking about the paradox of thrift . . .

2.  People confuse the individual with the aggregate.  In every case where an individual seems to be saving more and yet investment doesn’t rise, someone else is dissaving.  Thus when I loan someone (or institution) some money that they don’t invest, then I save and the borrower dissaves.   Aggregate saving is unchanged.

3.  What if I put cash under the bed?  I presumably get the cash from someone else.  So if me holding more cash is saving, then someone else holding less cash is dissaving.  If the government produces more cash and buys bonds, then it nets out to nothing if you view cash as a government liability.  The more interesting case is if we view cash as a real good, and the government feeds my appetite to hold more of this real good.  In that case it’s part of the capital stock but not a government liability, and real money hoarding means our real stock of transactions media goes up.  An OMP is both government saving and government investment.  That may seem an odd way to think about it, but it’s consistent with the definitions.  (Mike Sproul uses the liability approach; I use the real good approach.  S=I either way.);

4.  The argument for the paradox of thrift is that a higher propensity to save results in lower nominal interest rates, lower base velocity, and lower NGDP.  There are two reasons why I view this concept as being uninteresting:

a.  Even if correct, it would make more sense to call the problem “too much base money hoarding” not “too much saving.”

b.  It only applies if the Fed targets the money supply.  But they don’t, they target inflation (or inflation plus employment).  In that case the Fed would adjust the money supply to offset any change in V.  Now I suppose one could construct a model of “Fed fail,” but now we’d be far removed from the paradox of thrift, and would instead be obsessing about zero bounds and fear of unconventional policies, etc.

I’ve never liked the way textbooks treat macro.  They have an intro to money section with some basic accounting (MV=PY) and also the quantity theory of money (which 99.9% of students and 90% of economists think is somehow related to MV=PY.  It isn’t.)  There’s discussion of the German hyperinflation from a sort of hot potato perspective.  And then . . .

. . . and then it’s all dropped.  Then we go into Keynesian chapters where NGDP = C + I + G + NX and money affects interest rates and inflation is caused by “overheating economies” (like Zimbabwe?)

[Update:  Alex Tabarrok reminded me that the Tabarrok/Cowen text is an exception.]

I always thought the “classical dichotomy” provided the natural framework for explaining macro to students.  There’s the nominal economy, and there’s the real economy.  We could explain the nominal economy with a monetary (hot potato) framework and the real economy by assuming nominal shocks have real effects due to sticky wages and prices.  What could be simpler?

In this framework the AD curve is relabeled NE (nominal expenditure) and is a hyperbola.  Monetary theory explains why that hyperbola shifts northeast or southwest, and sticky wages and prices explain why the SRAS is upward sloping and the LRAS is vertical.  No need to throw out those early money chapters; you can tell students the “MV stuff” explains why the NE curve shifts left and right.

We would also de-emphasize “inflation shocks.” Recall that we should never “reason from a price change,” because inflation from the demand-side is a totally different phenomenon than inflation caused by supply shocks.  On the other hand we should always and everywhere reason from an unanticipated NGDP change, because those affect employment in predictable ways, regardless of whether they hit a healthy economy (1929) or an economy ravaged by debt problems (2008.)  They cause employment fluctuations.  Period, end of story.

Is it possible that we are starting to move to a NGDP-oriented view of the economy?  Perhaps this is just wishful thinking on my part, but I couldn’t help thinking that the reference to “nominalism” in this Financial Times article was hinting at an NGDP approach to macro:

While investors may have realised that a less rigid focus on inflation targeting will mean a shift in favour of equities and away from bonds, it is less clear that equity managers, or corporate managements, have realised that this change in the monetary policy framework in favour of “nominalism” will have a profound impact on the type of equities that outperform in coming years.

On the other hand, I was disturbed by this:

A significant change in monetary policy is under way around the world. From Abenomics in Japan, to the greater flexibility just afforded to the Bank of England with regards to pursuing its inflation target, and the Federal Reserve introducing an explicit unemployment target, it is clear that the days of inflation targeting are numbered.

The focus on lower inflation has lasted more than 30 years, resulting in three decades of falling inflation. In the US it dropped from 12 per cent in 1979 to below 2 per cent before the credit crunch hit. The policy also produced a 30-year bull market for bonds, as US Treasury yields fell from more than 15 per cent in the early 1980s to below 4 per cent by the mid-2000s.

However, this success in beating inflation has been achieved at the cost of a declining share of labour in national income.

It is not a coincidence that the share of labour in GDP peaks in the 1970s for both the US and the UK. Given that the largest element of costs was – and remains – labour, the fight against inflation amounted to a campaign to squeeze labour incomes.

Monetary contraction in 1981-82, and again in 1991, did temporarily raise unemployment.  But tight money has no long run effect on the share of national income going to labor, as wages and prices will eventually adjust to the new inflation rate.  And in the short run a contractionary policy can (sometimes) actually raise real wage rates (although) of course it reduces total real income earned by workers.

When two long run trends happen at the same time, don’t assume one causes the other.

HT:  Nicolas Goetzmann

. . . for public choice problems addressing long run fiscal issues.

Matt Yglesias has a post on consumption taxes:

This makes absolutely no sense. If you forego a massage this week, or wait a few years to get your house painted, is the labor for that massage or paint job “saved”? How about this year’s sunlight “” the ultimate source of that labor power? Can you use it next week, or next year? Understand: services comprise 80% of U.S. GDP. And that’s before you even think about Apple and similar, with their just-in-time, on-demand supply chains “” when you buy it, and only when you buy it, they produce it.

If you don’t buy it, it doesn’t get produced.

This is not really revelatory; I know these economists understand the paradox of thrift.

Define “understand.”

But they ignore and eschew it in their real-good, barter-based mental economic models. I would suggest that the explanation for this error of composition is revealed by Scott’s words: “morally grotesque.” Moralistic beliefs about how individual humans should behave make it impossible for many economists to embrace an aggregate economic reality of which they are fully cognizant.

I do agree that beliefs about what is “morally grotesque” make it impossible for economists to “embrace an aggregate economic reality of which they are fully cognizant,” which is why I ignore all progressive analysis of income inequality.

More seriously, it’s not so much that I have moralistic beliefs about how people should behave, but rather how they should be treated by the state.  I believe that people should not have to pay a higher tax rate simply because they prefer future consumption to current consumption.

PS.  For you new readers, Yglesias was stretching the truth a bit when he said I favored having the central bank “guarantee” full employment.  I favor NGDP targeting, which would (hopefully) minimize sub-optimal employment fluctuations.