Daddy, my tummy hurts!

Once a week the family gets a pizza and the little boy always eats too much. Later he moans that his tummy hurts. When the father tells his son not to eat so much, the little boy responds that pizza is yummy. His dad understands “revealed preference”, and hence is not very sympathetic.

Back in the 1980s, we all thought it was great when Volcker got inflation down to 4%. At that rate, inflation was hardly even noticeable. I actually think 2% inflation is even better than 4%, but only a tiny, tiny, tiny, tiny bit better. There’s almost no difference.

Today, economists often moan that we are cursed with sluggish recoveries from recessions because of the zero bound problem with interest rates. If you point out that the zero bound problem could be easily eliminated merely by raising the trend rate of inflation enough to keep nominal interest rates positive, they moan that they’d rather keep the inflation target at 2%.

Revealed preference suggests that if they aren’t even willing to take a trivial and almost costless change in the inflation target to fix this supposedly really serious problem, then obviously the problem can’t be all that bad. I conclude that the economics establishment is not sincere; they must have a hidden agenda somewhere.

In order of preference, I favor:

1. A 4% NGDP level target combined with a “whatever it takes” approach to “target the forecast”.

2. A 4% inflation target and Great Moderation-style monetary policy.
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3. The current 2% inflation target.

So I don’t favor raising the inflation target to 4% as a first best policy. Lower inflation really is a little bit better. On the other hand, current policy is so bad that a 4% inflation target would be far better than current policy. Indeed it’s not even close.

PS. And please don’t say, “But they struggled to raise inflation to 2% during 2015-18, so what makes you think they could target 4%?” Yes, it’s tough to raise inflation during a period of time where the Fed raises its target interest rate nine times. LOL.


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44 Responses to “Daddy, my tummy hurts!”

  1. Gravatar of Josh Josh
    6. August 2020 at 13:18

    > Lower inflation really is a little bit better.

    Do you take requests? Because as a non economist I would actually appreciate a post about why 2% inflation is better than 4%. (If that comes across as sarcastic, it’s not; I sincerely would like to see your thoughts on this).

    Knowing nothing about this on a technical level, a higher constant inflation seems so much better to me. Psychologically, I think most people would probably rather get a 5% raise than a 3% raise (nominal). And 2% on their savings account rather than 0%. Etc. People notice their raises more than the cost of milk going up I think.

    And it would seem to help the adjustment problem. It’s a lot easier to give someone a 1% raise than a 1% pay cut if things need to be adjusted downward.

    Maybe this is a bridge too far, but overall I feel like a lot of the populism we’ve seen might be caused at least partially by the low inflation. If people were getting bigger nominal raises I think they would feel much better about capitalism. But maybe I’m reaching there…

    (And I can understand why changing the target would be tough. Eg I have a mortgage under 3% which would become negative with higher inflation. And there are probably lots of similar problems in the world of finance. But that’s a transitional problem.)

    Anyway, I’m sure you know what you’re taking about here but I’m struggling to see what downsides I’m missing.

  2. Gravatar of leo leo
    6. August 2020 at 15:41

    Josh, inflation reduces the value of your money.
    As you increase the money supply, the value of one’s currency decreases. In other words, if you place money in a bank that earns 1%, and inflation is 3%, you just lost 2% of your wealth. Not good!

    In addition to that, what business would provide a 5% raise when inflation is costing their business money? They would not be in a position to do that. Are you talking about govt pensions and cola increases? In that case, inflation raises the cost to tax payers.

  3. Gravatar of foosion foosion
    6. August 2020 at 15:41

    As in the Beckworth – Sahm interview, targeting national income seems a much easier sell than targeting NGDP.

    What do you think?

    Level targeting is much better than claiming to try to hit 2% (or 4%) while consistently undershooting.

  4. Gravatar of Ray Lopez Ray Lopez
    6. August 2020 at 15:44

    @Josh – money is short term neutral. Only fools think a 4% raise that matches inflation is better than a 2% raise that matches inflation. Are you a fool?

    Sumner: “Revealed preference suggests that if they aren’t even willing to take a trivial and almost costless change in the inflation target to fix this supposedly really serious problem, then obviously the problem can’t be all that bad.” – right, it’s not. Money is short term neutral except during hyperinflation. 2% inflation a year is the same as 4% inflation is the same as 7% inflation and so on, until we hyperinflation, then all bets are off. BTW your NGDPLT could produce hyperinflation and is thus a dangerous and unnecessary experiment that thankfully I doubt will ever be done by the Fed, who has more or less ignored you. The wisdom of crowds (or Edmund Burke style conservatism).

  5. Gravatar of Benjamin Cole Benjamin Cole
    6. August 2020 at 15:51

    Great post, and it does seem that, at long last, at least a portion of the macroeconomics profession is losing its monomoniacal obsession with inflation rates.

    Yes, domestic prosperity is the name of the game.

    I prefer 5% NGDPLT. I suspect that strong nominal demand will result in real supply, if the economy is not too fettered by regulations and taxes.

    Another option that seems to work is an inflation band, rather than an inflation target. It may be that an inflation band gives central bankers a little bit of ease, when above the lower edge of the band.

    In central banker schools, they teach acolytes that to be above an inflation target is a craven moral sin, and that the best inflation target would be 0%, but we have 2% to satisfy the heathens.

  6. Gravatar of ssumner ssumner
    6. August 2020 at 16:06

    Josh, Good question (and Leo’s criticism of your question is wrong.) The main cost of 4% inflation is that it slightly increases the effective tax rate on capital income. There are a few other costs, but they are trivial. And even the capital income taxation cost could be easily offset with a slight tweak to the tax code.

  7. Gravatar of Kevin Erdmann Kevin Erdmann
    6. August 2020 at 17:10

    If the past decade is evidence that 2% inflation isn’t high enough to escape the zero lower bound, isn’t it also evidence that 4% NGDP growth isn’t high enough to escape the zero lower bound? Wouldn’t 5% be safer in the same way that 4% inflation would be?

  8. Gravatar of Benjamin Cole Benjamin Cole
    6. August 2020 at 17:22

    Dr. Ray Lopez:

    “2% inflation a year is the same as 4% inflation is the same as 7% inflation and so on, until we hyperinflation, then all bets are off.”

    Yes, there is some truth in what you say, and this germ of truth has led to many an “accelerating inflation” fear-mongering op-ed, and built the bulk of macroeconomic careers in the US in the last 40 years.

    Inflation! Danger, Will Robinson, Danger!

    Another Dr., Dr. Milton Friedman, even developed the NAIRU. This justified keeping 5% of the US labor unemployed in perpetuity (and helped shift income to capital from labor).

    But in postwar history, there have been dozens and dozens of countries and economies globally defined by moderate rates of inflation, which did not accelerate to hyperinflation.

    The inflation-mongers are lucky for the rare exceptions, Argentina and Zimbabwe.

    In fact, since 1980 or so, the trend has been to lower and lower rates of inflation almost everywhere, while real growth rates have also sagged.

    In any event, if the US wants to survive with something approaching free markets, policies will have to be geared to much tighter labor markets and much looser property markets.

    Biden is vowing an end to the “era of shareholder capitalism.”

    He looks like the next US president, and could have Donk majorities in House and Senate.

    Good luck out there. But you likely will have low inflation rates.

  9. Gravatar of Nick Nick
    6. August 2020 at 19:27

    Josh- I’m sorry that Sumner tried to appear to seriously address your question while simultaneously saying nothing…

    “The main cost of 4% inflation is that it slightly increases the effective tax rate on capital income. There are a few other costs, but they are trivial. And even the capital income taxation cost could be easily offset with a slight tweak to the tax code.” -Scott Sumner

    Wow. Nobel prize worthy. Einstein once said “ If you can’t explain it simply, you don’t understand it well enough.” Wow, was he ever right. Scott, was that actually you typing, or did Joe Biden sneak out of his basement, scale your cardboard tower (we all know you haven’t graduated to ivory yet), and string together some randomized Econ buzz words?

    An argument over whether 2% or 4% inflation targeting is prudent is obnoxious and non-productive. Inflation is bad. Artificial, centrally planned, higher prices benefit no one. In a truly healthy economy, the price level decreases, because capital is allowed to be deployed in the most efficient manner possible, leading to increasingly efficient allocation of resources, lowering the cost of production, and ultimately lowering the cost to the consumer. Think about how silly it is that supposed “experts” are capable of believing that economic prosperity can be achieved via the printing of paper… or in the case of QE… the printing of paper used to purchase future obligations to receive printed paper. Sometimes, when it rains, you get wet. Sometimes, when the central planners (shhhhh “the Fed”) print trillions of dollars, the value of the dollar goes down. Sometimes, when the cost of living explodes and productivity halts…zeroing in on 4% inflation or X amount nominal GDP will solve everything, right? It’s really that easy. Two words. Buy Gold.

  10. Gravatar of Steve J Steve J
    6. August 2020 at 21:22

    Nick are you saying deflation would be good? I am not a fan of people making money by putting it in a mattress. Inflation is a good incentive for people to do something with their money rather than sleep on it.

  11. Gravatar of Georg Georg
    6. August 2020 at 22:35

    So then if Capital Gains tax were to be abolished then 4% inflation would be more or less equally as desirable as 2% inflation, at least in terms of the effect on taxation of capital income?

    Assuming then that Cap Gains tax could be repealed (probably desirable but also probably politically impossible) which of the remaining trivial effects would dominate and thus determine which would be the better out of 2% inflation and 4% inflation?

  12. Gravatar of Postkey Postkey
    7. August 2020 at 00:04

    “Yes, it’s tough to raise inflation during a period of time where the Fed raises its target interest rate nine times. LOL.”

    Only if ‘one’ thinks that interest rates somehow affect economic growth in an inverse manner?

    “In Lee and Werner, Ecological Economics, 2018, we present half a century of evidence on the correlation & statistical causation between interest rates and economic activity in the US, Japan, Germany and the UK (quarterly data). In Lee & Werner (2018b) we present broader cross-country evidence from 19 countries and considering 3 different types of interest rates, using higher frequency monthly data

    Conclusion: Concerning correlation, we found that despite allowing for 2 years of leads and lags, the hypothesis that interest rates are inversely correlated with economic growth is rejected in 8 out of 8 cases. Instead, we found that interest rates are positively correlated with economic growth in 8 of 8 cases.
    Negative correlation clearly rejected in all cases. Positive correlation supported in all cases

    Statistical causation (Granger causality) between short-term and long-term interest rates on the one hand, and economic growth in the UK, US, Germany and Japan on the other: Conclusion: Causality from rates to growth rejected in 6 out of 8 cases. The alternative hypothesis that growth determines interest rates is supported in 8 out of 8 cases.

    “Conclusion
    Our empirical findings reject the canonical view that interest rates somehow affect economic growth in an inverse manner. To the contrary, long-term and short-term interest rates follow the trend of the business cycle, as measured by industrial production, in the same direction, in all countries examined.”

    https://citywire.co.uk/Publications/WEB_Resources/Creative/events/2018/Fixed-Income/RichardWerner.pdf

  13. Gravatar of Postkey Postkey
    7. August 2020 at 00:18

    “Think about how silly it is that supposed “experts” are capable of believing that economic prosperity can be achieved via the printing of paper… or in the case of QE… the printing of paper used to purchase future obligations to receive printed paper.”

    “Argument from incredulity, also known as argument from personal incredulity or appeal to common sense, is a fallacy in informal logic. It asserts that a proposition must be false because it contradicts one’s personal expectations or beliefs, or is difficult to imagine.”

  14. Gravatar of msgkings msgkings
    7. August 2020 at 09:06

    I find it helpful to understanding these ideas if I remember that money/cash/dollars/Euros/etc are not real. They are units of account and transaction to facilitate trade so we don’t have to barter our labor and goods.

    Cash in your bank account is simply the value of your unconsumed labor plus interest. When you think of it that way, it doesn’t matter what the ‘value’ of a dollar is. What matters are real things: labor, goods, investment and savings in real assets (stocks, private equity, real estate, gold).

    The ‘value’ of a dollar has declined dramatically since 1913. And real consumption and wealth and prosperity have increased dramatically over the same time frame. Dollars aren’t real.

    I might have this wrong but it helps me conceptualize.

  15. Gravatar of Postkey Postkey
    7. August 2020 at 09:25

    “Inflation can and does occur in a perfectly healthy economy. In fact, since 1913 when the Fed was founded inflation in the USA has consistently risen at 3.5% per year on average.3 One might assume that this means the country has experienced some great injustice, but the truth is that the 1900’s were characterized by the greatest economic expansion and wealth creation the world has ever seen. Despite the common citation that “the $USD has lost 90% of its value” Americans experienced an unprecedented period of prosperity during this inflation. In fact, the prosperity became so gross in the 1990’s that Americans felt entitled to second homes, second cars, and
    just about every other luxury good known to man. What has not occurred is hyperinflation, which is a very different animal than inflation.”

    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1799102

  16. Gravatar of ssumner ssumner
    7. August 2020 at 10:29

    Kevin, That’s why I added “level target combined with a “whatever it takes” approach to “target the forecast”.”

    But if that isn’t done then a higher rate would be better.

    Nick, I’m flattered by your praise, but you should cut back on the use of “Wow”. Once a comment is sufficient.

    Georg, Yes, on capital taxation. Other considerations include menu costs (price changes) and downward wage inflexibility. The optimal rate demands on which is more important, as they have opposite implications. It’s hard to estimate, mostly guesswork.

  17. Gravatar of Negation of Ideology Negation of Ideology
    7. August 2020 at 11:43

    Nick –

    You say “In a truly healthy economy, the price level decreases”

    You are making a classic mistake by not recognizing that there is no such thing as a neutral monetary policy. You complain that inflation is “central planning”, but you advocate your own central plan of deflation.

    You say “Artificial, centrally planned, higher prices benefit no one. ”

    The dollar itself is artificial, as is the deed to your house, stock certificates, etc. The supply of currency in circulation is arbitrary. Picking a supply that causes deflation is no less arbitrary than picking one that causes inflation.

    Of course, that doesn’t mean that some monetary policies aren’t better than others. The best monetary policy is one that doesn’t favor any good or service over any other, or favor creditors or debtors. For example, the gold standard is terrible because it’s a welfare program for people who own gold mines. Also, one than unpredictably jumps around is bad for the relationship between creditors and debtors. The best is one that is tied to the entire economy in a very predictable fashion.

    Therefore the best monetary policy is tying the dollar to NGDP per capita level. The next best is price level targeting, either PPI or CPI.

  18. Gravatar of Paul Paul
    7. August 2020 at 11:59

    “Yes, it’s tough to raise inflation during a period of time where the Fed raises its target interest rate nine times. LOL.”

    I thought higher interest rates were inflationary and therefore it was a fallacy to associating raising rates with deflationary policy…?

  19. Gravatar of Christian List Christian List
    7. August 2020 at 13:03

    Ray,

    What happened to the period from about March to May 2020 when you admitted that Scott was right? All gone? 2020 may have proven like no other year before that Scott is right.

    Paul,

    if I understood Scott correctly, interest rates by themselves don’t tell you anything about the actual stance of monetary policy.

    If anything then high interest rates are a look into the past and they tell you that money might have been to loose in the past. Vice versa with low interest rates. But it says nothing about the present.

  20. Gravatar of Trying to Learn Trying to Learn
    7. August 2020 at 13:37

    So Scott, you’re still highly critical of the Fed’s moves? I did see recently they said they won’t raise interest rates until inflation is actually at 2%. I understand this is not NGDPLT, but an improvement?

  21. Gravatar of Nick Nick
    7. August 2020 at 14:24

    Negation- I’m not advocating for deflation or centrally planned anything. I’m advocating for the power of free markets to decide what is most efficient to use as money… not a central bank. And we all know that answer is gold. Money may be neutral, but when you have a central bank that monetizes a governments debt, that government can use the proceeds to undeniably misallocate capital.

  22. Gravatar of Matthias Goergens Matthias Goergens
    8. August 2020 at 01:17

    Nick, why gold? When people around the world lose faith in their country’s fiat currency, they often turn to USD (and sometimes Euros etc) but almost never to gold.

  23. Gravatar of Spencer Hall Spencer Hall
    8. August 2020 at 03:41

    Scott Sumner is indubitably correct. It is axiomatic, a mathematical certainty, a truism. There is a “sweet spot”, where an injection of new money is robust, and not neutral, and not harmful.

    Rates-of-change in monetary flows, volume times transaction’s velocity equal RoC’s in P*T in American Yale Professor Irving Fisher’s truistic “equation of exchange” (where N-gDp serves as a subset and proxy for all physical transactions).

    I.e., nothing has changed in greater than 100 years. The distributed lag effect of money flows, have been curiously, mathematical constants – due to celestial gravity?

    The current monetary experiment, injection of record amounts of money, will demonstrate the obvious historical truth.

    But the nominal anchor is real output, not N-gDp. The downswing was inevitable:

    Parse date: real-output; inflation

    05/1/2019,,,,, 0.06 ,,,,, 0.10
    06/1/2019,,,,, 0.05 ,,,,, 0.09
    07/1/2019,,,,, 0.06 ,,,,, 0.09
    08/1/2019,,,,, 0.04 ,,,,, 0.09
    09/1/2019,,,,, 0.04 ,,,,, 0.10
    10/1/2019,,,,, 0.01 ,,,,, 0.07
    11/1/2019 ,,,,, 0.07 ,,,,, 0.09
    12/1/2019,,,,, 0.07 ,,,,, 0.07
    01/1/2020,,,,, 0.10 ,,,,, 0.13 *
    02/1/2020,,,,, 0.04 ,,,,, 0.13
    03/1/2020,,,,, 0.04 ,,,,, 0.09
    04/1/2020,,,,, 0.04 ,,,,, 0.08
    05/1/2020,,,,, 0.03 ,,,,, 0.09
    06/1/2020,,,,, 0.04 ,,,,, 0.09

    * = sharp drop in money flows, volume X’s velocity

    As I said: “The 4th qtr. 2019 is not the problem. The 1st qtr. 2020 will be negative.”
    Nov 26, 2019. 07:19 PMLink

  24. Gravatar of Spencer Hall Spencer Hall
    8. August 2020 at 03:49

    Negation of Ideology: re: ” The best monetary policy is one that doesn’t favor any good or service over any other, or favor creditors or debtors”

    Not so. We necessarily have regulated capitalism, not self-destructive lassez faire capitalism.

    Dr. Leland James Prichard, Ph.D. Economics – Chicago 1933, M.S. Statistics, Syracuse (a man 30x smarter than Albert Einstein):

    NSA N-gDp’s growth rates by decade, percent ∆:
    1970’s growth = 1.76
    1980’s growth = 1.15
    1990’s growth = 0.76
    2000’s growth = 0.52
    2010’s growth = 0.43
    Unless savings are activated, put back to work, a dampening economic impact, a deceleration in money velocity, is engendered and metastases, resulting in secular strangulation (not because of robotics, not because of demographics, not because of globalization).
    As the economic syllogism posits:
    #1) “Savings require prompt utilization if the circuit flow of funds is to be maintained and deflationary effects avoided”…
    #2) ”The growth of commercial bank-held time “savings” deposits shrinks aggregate demand and therefore produces adverse effects on gDp”…
    #3) ”The stoppage in the flow of funds, which is an inexorable part of time-deposit banking, would tend to have a longer-term debilitating effect on demands, particularly the demands for capital goods.” Circa 1959

    The answer to increased velocity, increased AD, increased incomes (the ingredient from which debt is paid), is to gradually drive the commercial banks out of the savings business. This will not reduce the size of the payment’s system. It will make the banks more profitable.

    Alvin Hansen’s secular stagnation is not due to demographics, not due to globalization, not due to robotics. It is due to the Keynesian macro-economic persuasion that maintains a commercial bank is a financial intermediary serving to join savers with borrowers.

  25. Gravatar of Spencer Hall Spencer Hall
    8. August 2020 at 04:04

    re: “he main cost of 4% inflation is that it slightly increases the effective tax rate on capital income.”

    Prices would then double in 18 years. Not acceptable. To implement such a policy would require an injection of money products substantially in excess of savings products.

    An increase in money products decreases the real rate of interest and has a negative economic multiplier.

    An increase in savings products increases the real rate of interest and has a positive economic multiplier.

    An increase in money products will push savings into time deposits thereby destroying velocity. So you get FOMC schizophrenia (like in July 2008): Do I stop because inflation is increasing? Or do I go because R-gDp is falling? — simply because, in the latter stages of an economic expansion, as interest rates rise, savings become increasingly impounded within the confines of the payment’s system, thereby destroying money velocity –and thus AD.

    If the FED tries to offset this dilemma it will result in higher and more destructive inflation.

  26. Gravatar of Spencer Hall Spencer Hall
    8. August 2020 at 04:37

    Every semester Dr. Leland James Pritchard, a man 30 times smarter than Albert Einstein, handed out a paper to his Money and Banking students detailing double-entry bookkeeping on a national scale.

    Like Dr. William Barnett said (a former NSA Rocket Scientist).
    “the Fed should establish a “Bureau of Financial Statistics”. You can’t duplicate this accounting today.

    1979: Double-entry Bookkeeping on a National Scale
    ————————–

    Loans and investments 1229.8
    Cash and Due from Banks 169.5
    Total Assets—Total Liabilities and Net Worth 1480.3
    Demand Deposits 400.5
    Time deposits 675.8
    Borrowings 180.5 (principally e-$s since 1969)
    Currency outside the banks 106.1
    Reserve Bank Credit 128.3

    MONETARY AND BANKING CHANGES End of 1939 to end of 1979 (figures in billions of dollars)

    (1) Net effect on the volume of time and demand deposits and borrowing of all factors, except commercial bank credit (principally capital accounts) 13.5
    (2) Net expansion of commercial bank credit 1189.1
    (3) Net increased in time and demand deposits and borrowings 1202.6

    Source: Computed from data reported in All-Bank Statistics, U.S. 1896-1955 Federal Reserve; and the Federal Reserve Bulletin

    The fact is that from a systems’ standpoint the banks pay for their earning assets with new money – not existing deposits. This drastically changes everything in macro. For instance, the source of time deposits is demand deposits, directly or indirectly via the currency route (never more than a short-term situation since 1930), or through the bank’s undivided accounts. An increase in interest-bearing deposits depletes non-interest-bearing deposits, dollar for dollar.

    I.e., the bank collectively pay for what they already own (very stupid and less profitable). So, domestic banks could undercut offshore lending, FX.

    M1 = currency outside the banks plus DD, including U.S. Treasury General Fund Account
    M2 = M1 plus all time deposits, including large CDs, in the DFIs

  27. Gravatar of Spencer Hall Spencer Hall
    8. August 2020 at 05:39

    What’s more interesting is the so-called world-wide “dollar shortage”.

    When the U.S. sneezes, the rest of the world catches a cold. The dollar shortage arises when the Federal Reserve maintains too tight of a monetary policy.

    Like when “On August 11, 2015, the People’s Bank of China (PBOC) surprised markets with three consecutive devaluations of the yuan renminbi or yuan (CNY), knocking over 3% off its value. ”

    As I said:

    Prices troughed in Jan this year as long-term money flows fell by 80 percent from 1/2013 to 1/2016. Oil fell by 70 percent during the same period.
    Dec 16, 2016. 06:41 PMLink

  28. Gravatar of Nick Nick
    8. August 2020 at 06:02

    Matthius- It doesn’t have to be gold. I am just advocating to allow the free market to determine what is the best form of money, or monies. I just happen to believe that over many years, that the market has already made this decision, and it happens to be gold. People don’t understand that free markets are also capable of seeking what can serve as the most efficient form of money. Gold COULD be used in a very large variety of ways other than its primary use as money. Why isn’t used in these ways? Because it’s expensive. Why is it expensive? Because the value it adds to society in its role as money is greater than the value it could add if used in alternative applications. And to reiterate, the solution doesn’t have to be gold. The beauty of free market competition has recently brought cryptos into the realm. Will they succeed? I don’t think so, but who knows? The market will decide.

  29. Gravatar of Gene Frenkle Gene Frenkle
    8. August 2020 at 07:52

    Based on the dates you referenced there is clearly a relationship between oil prices and inflation in America which makes sense in light of America being an energy intensive consumer spending economy. Going forward energy will not be an issue so I believe the Fed will have more leeway because high energy prices won’t be gumming up the economy. So capital searches for yield and with high inflation capital will be searching for higher yield which should lead to stronger economic growth…as long as the economy is not dysfunctional. So an example of a dysfunctional economy was 2001-2008 in which several major consumer spending economies couldn’t process high oil prices (and in America high natural gas prices) and so there was a dearth of quality investment opportunities which led to malinvestment as capital searched for yield.

  30. Gravatar of Spencer Hall Spencer Hall
    8. August 2020 at 08:08

    @Gene Frenkle: re: “So an example of a dysfunctional economy was 2001-2008 in which several major consumer spending economies couldn’t process high oil prices”

    That was different, before the prudential reserve E-$ market started contracting. Under a U.S. regime of paying interest on interbank demand deposits, the E-$ market will contract.

  31. Gravatar of Spencer Hall Spencer Hall
    8. August 2020 at 08:11

    @Nick re: “I just happen to believe that over many years, that the market has already made this decision, and it happens to be gold.”

    Even Alan Greenspan knows that’s impossible. See his excellent article “Can the U.S. Return to the Gold Standard” in the WSJ on 9/1/1981.

  32. Gravatar of Spencer Hall Spencer Hall
    8. August 2020 at 08:18

    The solution to Alvin Hansen’s 1938 thesis, a return to the U.S. Golden Era in Capitalism, is to drive the commercial banks out of the savings business.

    Basically, the U.S. Golden Era in capitalism was where savings velocity increased by 2/3 while the money stock increased by 1/3. Today, the situation has been transposed (the impoundment and ensconcing of monetary savings), with money increasing markedly while velocity falls.

    During the U.S. Golden Era in Capitalism (not optimized), the annual compounded rate of increase in our means-of-payment money supply was about 2 percent. The nonbanks grew faster than the commercial banks (which made Citicorp’s Walter Wriston jealous), and thereby a higher percentage of savings was utilized (through direct and indirect investment) and was also FSLIC and NCUA insured.

    And during this same period, 1955-1964, the rate of inflation, based on the Consumer Price Index, increased at an annual rate of 1.4 percent. Unemployment averaged 5.4 percent.

    Things ended in 1965. That’s when the commercial banks began to outbid the non-banks for loan-funds (resulting in disintermediation of just the thrifts). I.e., the nonbanks are not in competition with the banks. The NBFIs are the DFI’s customers.

    What you can take away from George Baily’s “It’s a Wonderful Life” is varied meanings and thus different applications. The fact is that the U.S. Golden Era in Capitalism was where small savings were pooled, expeditiously activated (put back to work), and government insured – in the Savings and Loan Associations, Mutual Savings Banks, and Credit Unions. I.e., money velocity accelerated during this prosperous period (simply by activating monetary savings).

    Government polices underpinned targeted real investment, aka, “the Servicemen’s Readjustment Act of 1944, the G.I. Bill was created to help veterans of World War II. It established hospitals, made low-interest mortgages available and granted stipends covering tuition and expenses for veterans attending college or trade schools”

  33. Gravatar of Spencer Hall Spencer Hall
    8. August 2020 at 08:24

    Dr. Philip George has a formula for FOMC schizophrenia. Link: “The Riddle of Money Finally Solved”
    http://www.philipji.com/riddle-of-money/

    “When interest rates go up, flows into savings and time deposits increase” ( the ratio of M1 to the sum of 12 months savings ).

  34. Gravatar of Gene Frenkle Gene Frenkle
    8. August 2020 at 10:05

    Spencer Hall, in general families with young children make the best financial decisions which is why the “Golden Era” corresponded with the Baby Boom…so very little malinvestment. Plus the boomer parents believed they would die while working so saving for retirement probably wasn’t a priority. Furthermore at that time health care was not nearly as advanced and so it was cheaper and college was cheaper (and not even necessary to get a good job) so you didn’t have those things sucking away consumer spending. So to get back to the Golden Era you would need families making babies along with no worries about retirement and health care and college funds. Parents saving for college should be gone yesterday along with student loans…throw those things in the trash heap of history ASAP! Retirement worries could be solved by giving every baby $3k that is invested in an S&P index fund and it grows tax free until 65…the government already picks up $10k maternity benefits for half of babies so why not just make it $13k?? America does have the best health care system in the world but it could almost as good by spending a lot less…Canada and UK spend much less for slightly worse outcomes. Then we reform the tax code to funnel money to parents with young children and away from people without children buying BMWs and expensive condos and lavish vacations.

  35. Gravatar of Spencer Hall Spencer Hall
    8. August 2020 at 11:18

    @ Gene Frenkle re: “targeted investment”

    There is $15,000,000,000,000.00 in frozen savings in our payment’s system. Banks create deposits, they don’t loan out deposits. From the standpoint of the commercial banks, the monetary savings practices of the public are reflected in the velocity of their deposits and not in their volume.

    Prima facie evidence:

    (1) The 1966 Interest Rate Adjustment Act is prima facie evidence (lowered Reg. Q ceilings for just the commercial banks reversing the 1966 “credit crunch”).
    (2) The DIDMCA of March 31st is prima facie evidence (caused the 1985-1996 Savings and Loan Association Crisis and the July 1990-Mar 1991 recession)
    (3) The 1981 “time bomb” is prima facie evidence (produced 19.1% N-gNp in the 1st qtr. 1981)
    (4) The 2012 expiration of the FDIC’s unlimited transactions’ deposit insurance is prima facie evidence (responsible for the “taper tantrum”, in spite of the budget sequestration in 2013, the automatic spending cuts)
    (5) The introduction of the payment of interest on interbank demand deposits is prima facie evidence (resulted in the nonbanks shrinking by $6.2 trillion while the banks grew by $3.6 trillion, i.e., it destroyed the nonbanks who were rolling over short term repos to fund their earning assets)
    (6) The September 2019 Repo Crisis is prima facie evidence.

    Secular strangulation is none other than the impoundment and ensconcing of monetary savings in the payment’s system (where all monetary savings originate).

  36. Gravatar of Spencer Hall Spencer Hall
    8. August 2020 at 11:24

    A theoretical explanation was advanced by Dr. Lester Chandler in 1961 (which explains everything since) to support the conclusion that there was no difference between money and liquid assets (new money substitutes).

    It was based upon the following assumptions:

    (1) That monetary policy has as an objective a certain level of spending for N-gDp (sound familiar?, viz., N-gDp targeting?), and that a growth in time/savings deposit classifications will not, per se, alter this objective. And that a shift from demand to time deposits will also not, per se, alter this objective;
    (2) That a shift from demand to time deposits involves a decrease in the demand for money balances and that this shift will be reflected in an offsetting increase in the velocity of money.
    (3) To prevent the increase in Vt from altering the desired level of spending for N-gDp, it is necessary for the FRB-NY trading desk to prevent the diminished money supply brought about by the shift from demand to time deposits from being replenished through an expansion of bank credit;
    (4) To prevent the expansion of bank credit requires that the trading desk “mop up” al excess reserves created by the shift from demand to time deposit classifications.
    With the monetization of time deposits (end of gate keeping restrictions), as hypothesized from 1961 until 1981 Dr. Chandler was correct.

    From 1981 forward Dr. Chandler was wrong. As Dr. Leland Prichard posited: It seems quite probable that the growth of time deposits shrinks aggregate demand and therefore produces adverse effects on N-gDp. I.e., it seems highly improbable, and in contradiction to Professor Chandler’s theoretical analysis: that the stoppage in the flow of these funds is entirely compensated for by an increased velocity of the remaining demand deposits.

    They weren’t compensated after 1981. Money velocity has decelerated since 1981. Prichard in May 1980 pontificated that:
    “The Depository Institutions Monetary Control Act will have a pronounced effect in reducing money velocity”. The DIDMCA destroyed the nonbanks.

    I.e., all monetary savings (funds held beyond the income period in which received), commercial bank-held savings, are from a macro-accounting perspective, un-used and un-spent, lost to both consumption and investment, indeed to any type of payment or expenditure. This is the source of Alvin Hansen’s secular stagnation – not robotics, not demographics, not globalization.

  37. Gravatar of Spencer Hall Spencer Hall
    8. August 2020 at 11:35

    All monetary savings originate within the payment’s system. The source of interest-bearing deposits is other bank deposits, directly or indirectly via the currency route, or through the bank’s undivided profits accounts. The recipient bank’s primary deposit is a derivative deposit from a system’s perspective.

    In other words, the commercial banks cannot expand their earning assets by attracting something that they collectively already own. Since time deposits originate within the banking system, there cannot be an “inflow” of time deposits and the growth of time deposits cannot, per se, increase the size of the banking system. But because of the economies of scale, the largest banks can outbid / redistribute the smaller banks’ deposits (i.e., monopolistic price practicing).

    Transferring saved demand or time deposits through the nonbanks cannot reduce the size of the payment’s system. Deposits are simply transferred from the saver to the nonbank to the borrower, etc. But the reduction in the size of the nonbanks destroys money velocity (the activation of savings products, literally destroying the savings investment process). I.e., the preferential interest rate differential (paying the banks interest on reserve balances), reduces the real rate of interest and destroys CAPEX.

    Savers never transfer their savings out of the payments system in the first place, savings never leave the payment’s system unless holders hoard currency or convert to other national currencies, e.g., FDI. There is just an exchange in the ownership of pre-existing deposit liabilities in the banking system, a velocity relationship. Where do you think velocity has gone since 1981?

    An increase in bank CDs adds nothing to N-gDp.

    In the context of their lending operations it is only possible to reduce bank assets, and deposits, by retiring bank-held loans, e.g., for the saver-holder to use his funds for the payment of a bank loan, interest on a bank loan for the payment of a bank service, or for the purchase from their banks of any type of commercial bank security obligation, e.g., banks stocks, debentures, etc.

    The NBFIs, e.g., hedge funds, insurance companies, pension funds and shadow banks are the DFI’s (regulated member banks), customers. The DFIs process all of the NBFI’s underlying payment transactions, both clearings, and settlements. The prosperity of the DFIs is dependent upon the prosperity of the NBFIs. Negative interbank demand deposits won’t get the banks to lend without an increase in bankable opportunities.

  38. Gravatar of Spencer Hall Spencer Hall
    8. August 2020 at 11:57

    As was forewarned:

    The deceleration in N-gDp was axiomatic, as predicted in 1961:

    NSA N-gDp’s growth rates by decade, percent ∆:

    1970’s growth = 1.76
    1980’s growth = 1.15
    1990’s growth = 0.76
    2000’s growth = 0.52
    2010’s growth = 0.43

    Frictionless financial perpetual motion requires that, income not spent (monetary savings, commercial bank-held savings) is quickly reintroduced into the economy, completing the circuit income and transactions’ velocity of funds (*circular flow*), thereby sustaining and promoting economic momentum. The utilization of savings via real investment outlets has a positive economic multiplier (increases productivity, real wages, as well as the real rate of interest).

    Unless commercial bank-held savings, monetary savings, are expeditiously activated, put back to work, back into circulation, a dampening economic impact, a deceleration in money velocity, is engendered and metastases, resulting in Alvin Hansen’s 1938 secular strangulation (not because of the widely bandied about, erroneously believed: robotics, not because of demographics, not because of globalization).

  39. Gravatar of Postkey Postkey
    8. August 2020 at 12:52

    ” . . . why the “Golden Era” corresponded with the Baby Boom…”
    Corresponded with cheap oil?

    “A barrel of conventional crude oil contains the equivalent of roughly 4.5 years of continuous human labour; or around 11 years at 35 hours per week, 48 weeks of the year.  But the capitalist doesn’t pay for the value of the fuel, merely the cost of extracting it.  For a mere £49 (at pre-pandemic prices) the capitalist purchases £330,000 worth of work (at the current UK median wage).  It is the exploitation of fossil fuels rather than the exploitation of labour which generates the vast majority of the surplus value in an industrial economy. . . .

    As Nicole Foss once put it – if conventional oil was like drinking draught beer from a glass, fracking was the equivalent of sucking the spilled dregs from the carpet.”

    https://consciousnessofsheep.co.uk/2020/05/26/two-money-tricks/?fbclid=IwAR1rOz0jexO2dIIldSlseh-8-EqES4oYZcBTvHMtW-JyBgMHB6xgfOOsbBI

  40. Gravatar of Gene Frenkle Gene Frenkle
    8. August 2020 at 12:59

    Spencer Hall, people spending most of their paycheck at businesses in which most of the profits stay in the community is what was going on. So the local movie theater would feature a movie made in Hollywood but most things in town would have been sourced locally/regionally with profits that stay local and are reinvested in the local economy as long as the economy appears fundamentally sound. So as a gen xer I remember a time before Walmart and Macy’s and CVS and McDonalds in every town.

  41. Gravatar of Gene Frenkle Gene Frenkle
    8. August 2020 at 13:41

    Cheap energy has been essential to the American economy because as an energy intensive consumer spending economy our economy can’t process expensive energy the way export economies including energy into the export and selling it to an oil exporter. Fracking and technological advances in renewables mean that the era of the American economy being constrained by energy prices is behind us. Obviously frackers are going to experience a lot of pain over the next several years and then I predict the fossil fuel industry will be on a very slow decline into obsolescence.

  42. Gravatar of ssumner ssumner
    8. August 2020 at 13:43

    Paul, That too.

    Trying to Learn, If it’s an improvement, it’s a very tiny one.

    Everyone else, LOL.

  43. Gravatar of Spencer Hall Spencer Hall
    9. August 2020 at 03:02

    Money velocity has fallen because savings have been impounded. Banks don’t loan out savings period.

    Contrary to Bankrupt-u-Bernanke’s claim that: “Money is fungible”…“One dollar is like any other”, pg. 357 in “The Courage to Act”, the utilization of savings is a catalyst, it is not a matching of economic accounts, not a 1-2-1 economic transaction (correlation between two sets). This is demonstrated by debits to particular deposit accounts.

    The regulatory release (yes it is up to Congress), of savings invokes a spontaneous chain reaction, an expanding sequence of reactions, a self-propelling and amplifying chain of events

    In my application of this theory, the release of savings, was as I commented on 12-16-12, 01:50 PM #1 when the FDIC’s unlimited transaction deposit insurance was reduced to $250,000:

    “We’re close to seeing the real power of OMOs. R-gDp is likely to accelerate earlier and faster than anyone now expects. The roc in M*Vt before any new stimulus is already above average.
    With low inflation (given some deficit resolution), Jan-Apr could be a zinger”

    Danielle Dimartino Booth’s in her book gets it backwards too: “Fed Up”, pg. 218

    “Before the financial crisis, accounts were insured up to the first $100,000 by the FDIC. That limit kept enormous sums *in the shadow banking system* [sic].

    The boom in housing was fueled by savings products (securitization, rmbs, etc.), by an increase in the transactions’ velocity of circulation, bank debits.

    Since the FED discontinued the G.6 Debit and Demand Deposit Turnover release in Sept. 1996, this nonbank activity has been obfuscated.

    Thus, we got the “taper tantrum” and subsequently above average R-gDp and N-gDp growth rates by putting savings back to work (simply by increasing money velocity).

    Zinger – a surprise, shock, or piece of electrifying news.

    So we had a “taper tantrum” and a temporary rise in gDp:
    01/1/2013 ,,,,, 4.4
    04/1/2013 ,,,,, 1.6
    07/1/2013 ,,,,, 5.1
    10/1/2013 ,,,,, 6.1
    01/1/2014 ,,,,, 0.7
    04/1/2014 ,,,,, 7.0
    07/1/2014 ,,,,, 7.1
    10/1/2014 ,,,,, 2.6
    01/1/2015 ,,,,, 3.2
    04/1/2015 ,,,,, 5.0
    That’s called a “predictive success”. “The only relevant test of the validity of a hypothesis is comparison of prediction with experience.” – Milton Friedman

    The practical expedient to our, to the world’s economic malaise, is to drive the commercial banks out of the savings business, thereby distributing idle savings back to targeted economic work, so as to expand real output.

    As Einstein said: “The deeper we penetrate and the more extensive our theories become the less empirical knowledge is needed to determine those theories.” The application of theory is conceptualization.

  44. Gravatar of Spencer Hall Spencer Hall
    13. August 2020 at 05:42

    What’s funny is the charge that either velocity has changed or the natural rate of interest has changed. Neither is correct. What’s changed is the distributed lag effect of money flows.

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