Too wide a scope for a blog post? You betcha. But this was going to be the core of my PhD Dissertation back when I was in such a program and had delusions of adequacy. So those who wonder “WTF does any of this have to do with labor hours?” Well bear with me. Or scroll away. Because much tedium and obscurity is found under the fold. A pure dose of ‘tl/dr’ which doesn’t even get to either Smith or Marx. Yet.
Art at The New Arthurian Economics and I are looking at the relationship between debt and economic growth. Art started with an observation of two FRED series, total credit market debt owed (TCMDO) and Gross Domestic Product (GDP, nominal or GDPC1, inflation adjusted – take your pick.)
Graph 1, from FRED, shows these data series. I’ve chosen nominal GDP and, for reference, also included the total Federal Debt.
In 1950, TCMDO was about 1.3 times GDP, but growing a bit more quickly. By 1980, the ratio was 1.6, and by 1987 it was greater than 2. Now that ratio is approaching 4. Note that TCMDO is also close to 4 times greater than total public debt. This is why Art and I agree that private, not public debt is the problem that needs to be addressed, but is largely ignored.
Linked here are Art’s posts with graphs of YoY growth in both factors, pre 1980 and post-1980. Pre 1980, their moves are similar in magnitude, and pretty well coordinated. Post 1980 there is still some occasional similarity of motion, but the coordination breaks down and debt growth is generally quite a bit higher than GDP growth. The 80′s in particular stand out as being starkly different from the previous period.
Graph 2 shows the entire data set, since 1952.
These observations led Art to the reasonable hypothesis that, “Output growth slowed when debt became excessive.” This, in fact, might explain the great stagnation.
I suggested, and Art accepted two corollaries to his hypothesis.
1) There is a non-excessive amount of debt. Let’s call it “just right.”
2) Below the “just right” amount, there might also be “not enough.”
Actually, there is a lower level hypothesis, to which Art’s is corollary: That there is a functional relationship between debt and growth, in which growth is the dependent variable.
This is what I will explore in this post.
Graph 3 is a scatter plot of GDP vs TCMDO YoY % change for each, FRED quarterly data from Q4, 1952 through Q2, 2012, with a best fit straight line included.
The relationship is quite clearly positive. The R^2 value at .39 is rather low, but not terrible. There is quite a bit of scatter in the data. Note the circle of data points around the left end of the line. More on that later.
Next, I divided the data by decades, frex, 1961-1970. This admittedly simplistic data parsing reveals that the slope and R^2 values are strongly variable over time. Graph 4 shows the scatter plot along with the slope and R^2 values for each decade. These data values are arranged in the chart in chronological order and color matched with the corresponding data points.
I’ve added a brown line connecting the dots for the first decade of this century. The chronology proceeds from a cluster near the center of the graph into a clockwise circular spiral.
Graph 5 shows how the slope and R^2 vary over time.
After the 60′s, the slope plummets, and by the 80′s R^2 is a laughable 0.035. Though the slope has remained low, R^2 has since recovered to 0.38, which is near the whole data set value of 0.39, and only slightly less than the 0.40 to 0.44 of the first three decades.
The slope changes can be interpreted as generally less GDP bang for the TCMDO buck, as the TCMDO/GDP ratio increases. This is totally consistent with Art’s hypothesis.
I have more to say about the GDP -TCMDO relationship, but this post is getting long, so I’ll save it for a follow-up.
For now, I’ll close with a few questions.
1) Do you think we’re on to something?
2) What do you think of the methodology?
3) “Excessive debt” is suggestive, but non-specific. How should this concept be quantized?
4) How should I go at exploring corollaries 1 and 2 mentioned after Graph 2?
5) Any thoughts on what was there about the 80′s that blew up the prior debt – GDP relationship?
6) Is there such a thing as productive vs non-productive debt, and how would they be characterized?
I look forward to your constructive comments.
The President of the Federal Reserve Bank of Philadelphia:
We have been putting out credit in a period of depression, when it is not wanted and could not be used, and will have to withdraw credit when it is wanted and can be used.
Indeed, reviewing the Calmoris and Wheelock article from which I pulled that quote, we find the same mistakes being made: excess reserves confused with circulating money and therefore treated as harbingers of inflation, squealing for austerity,*** sterilization of shifts in reserves in a desperate attempt to avoid non-visible inflation.
As Owen Wilson’s Gil says in Midnight in Paris, we have antibiotics; the people in Fin de siècle Paris didn’t. It’s just one of our other “sciences” that appears not to have advanced.
*Michael D. Bordo;Claudia Goldin;Eugene N. White. The Defining Moment: The Great Depression and the American Economy in the Twentieth Century (National Bureau of Economic Research Project Report) (p. 36). Kindle Edition.
***The Norris quote above begins:
We believe that the correction must come about through reduced production, reduced inventories, the gradual reduction of consumer credit, the liquidation of security loans, and the accumulation of savings through the exercise of thrift. These are slow and simple remedies, but just as there is no “royal road to knowledge,” we believe there is no short cut or panacea for the rectification of existing conditions.
$40,000 is the annual tuition at Providence College today.
$1.80 per hour is equivalent to the following: $14.40/hour standard of living, $17.80 real value, $18.20 unskilled labor and $22.00/hour production labor.
Tuition of $500 is equivalent to the following: $4010.00 standard of living, $4960 real value, $5050 unskilled labor and $6120.00 production labor
Thelow-wage benchmark set by the UAW has already set off a competitivestruggle in the global auto industry, with Fiat-Chrysler boss SergioMarchionne telling Italian workers they must accept American-styleconcessions or he will move production to North America for cheaperlabor.
“The dream seems to now only be adefinite with a 2 person, college educated and working household. That combination is not far from being in the 10% group. Thus, wehave raised the dream to something beyond which a large portion ofthe population will not reach considering only 28% have a 4 yeardegree even though 64% of high school students are entering college. It looks even worse with people suggesting that you need an IQ of 110to succeed in college. I mean, can we push the dream any further outor be anymore aristocratic in our arguments? “
In 2003, the homeownership rate for upper-income families withchildren was 90.8 percent, while the rate for their low- tomoderate-income counterparts was significantly lower at 59.6 percent– yet in 1978 some 62.5 percent of low-to moderate-income workingfamilies with children owned their homes. Ultimately, had the 1978homeownership rates for working families with children prevailed in2003, an additional 2.3 million children would now be living inowner-occupied homes.
How’s this little bit of history change your ideas about what toblame for the current housing/mortgage mess? I suppose if you areall for a future that is less than what was accomplished in the pastthen blaming government for promoting housing and people for spendingbeyond there means is all right by you.
No one in the middle class of yore was rich by any means. But,what they had was a life much freer of risk than today. What theylived in was an environment that provided the means to manage therisk of life and living. When we are told by those running for or inoffice that Americans need to be more…(fill in the blank) they aresuggesting such from within their own experience of having grown upin a socially constructed via government environment that was devoidof certain risks of living based on one’s income. In other words,you would not be told that the requirement for food stamps would meanyou had to have less than $2000 in savings.
The removal of these risks allowed one to take what theypersonally had (natural ability and otherwise) and grow it into alife where economically more of life’s risks could be taken onindividually. It was an environment which removed the concept ofluck from the social justice equation.
This environment was not all welfare. It was an environment thatassured a person of common acuity could live a life free from therisk of weather, malnourishment, illness and aging. It was anenvironment that produced an economy such that the vast majority ofthe 72% without a college education were living this minimal risklife. We had an environment which supported the economic life journeyof the autoworker, simultaneously supporting the economic life journey of Mr.Bacon’s experience, simultaneous supporting the economic life journey of anindividual such as President Obama.
It was an economic environment which produced a directrelationship between income/wealth and risk absorption. As incomeand wealth went up, so did the absorption of risk and vice versa. Today we
Our past economic environment also produced a direct relationshipbetween income-wealth and luck. Again, as income-wealth increased,your success was more dependent on luck and vice versa. This too hasbeen reversed as we see with the Washington revolving door and evergreater capture of the nations wealth as one’s income-wealthincreases. The environment produces an ever stronger assurance thatincome and wealth will increase as they both increase. This isunlike the experience of the middle class including all the highly educatedpeople who find themselves under employed or unemployed do to theshear luck of having chosen wrong. Today the closer you are to zeroon the line of income-wealth, the luckier you need to be.
I’ll leave you with this, the class warfare. There is classwarfare. It has always been with us, since the writing of theConstitution. However, I believe the current theater is the mostdevious the vast majority of the US population has ever faced. Thisis because of the two parties in this seemingly perpetual human quest,one has successfully cloaked themselves in the costume worn of athird party observer effectively immunizing themselves from the pain of the fight via camouflageof a messenger. I even suspect some aregaining a wee bit of entertainment in their ability to manipulate theircounterparts into fighting among themselves. I speak of the laborclass successfully being divided such that those who labor in theprivate sector of the economy accuses those who labor in the publicsector of the economy for their poor economic position and the publicsector laborer does not recognizing themselves in the private laborworld. I tell you, the false messenger is recognized in that theirlabor is money. It is not in their mind or body. Warren Buffet maywant to be taxed more, but Warren Buffet is not working his money asthe Kock Brothers are working theirs…and Warren Buffet isbenefiting from the productivity of the Kock’s Brother’s money.
Next up is 1936′s tax table.
When I left this series in September, I had introduced the idea of looking at past tax tables as a means of understanding how We the People define rich. One specific note from history was a surcharge on top of themarginal tax rates to pay for the Great One (WWII). Obviously, that aspect of our moral character has gone right out the window.
But before you get to excited aboutthis suggesting or, that I am saying that the poor need to pay moretaxes and the rich are over taxed consider the tax table from 1936,its lowest income tax bracket is 4%. This is on an income up to$4000. Let’s bring that forward to 2010 using my favorite money converter. CPI states that $4000 is now $60,400. Today’s rate for $16,750 to $68,000 is 15% instead of 4%. Of course,I like the unskilled labor and nominal GDP/capita numbers of $145,000and $275,000 respectfully.
Alright, I’ll be fair. The lowest rate in1967 is 14% for up to $1000. That figures to 2010 of $6540 CPI,$6670 unskilled and $11200 nominal GDP/capita. Though, the $4000 in1936 is $9640 in 1967 which puts one in the 22% bracket ofthat year. Using the $12000 for the top of that 1967 bracket brings us to$78,300 CPI adjusted gross income for 2010. $78,300 puts one in the25% bracket for 2010. Obviously another issue we have here when itcomes to setting up marginal rates based on historical records is howmuch the base (adjusted gross income) is effected by how the CPI iscalculated. Any way you figure it, we have been pushing the marginalrate higher and deeper into the lower end of the income pool.
by Mike Kimel
I was searching for some information and I stumbled on a post Scott Sumner wrote last year about Robert Skidelsky’s biography of John Maynard Keynes. I haven’t read Skidelsky’s book, nor do I know Skidelsky, and its been awful long time since I read Keynes, but this seems an odd complaint:
I’m afraid that his analysis is both misleading and inaccurate. The US gradually depreciated the dollar between April 1933 and February 1934. During that period unemployment was nearly 25% and T-bill yields were close to zero. Keynes argued that monetary stimulus would not be effective under those circumstances, and Skidelsky seems to accept his interpretation (which was published in the NYT during December 1933.)
[Note that Keynes certainly did believe in the "pushing on a string" theory--I frequently get commenters insisting that Keynes didn't believe in liquidity traps.]
Unfortunately, Keynes and Skidelsky are wrong. The US Wholesale Price Index rose by more than 20% between March 1933 and March 1934. In the Keynesian model that’s not supposed to happen. The broader “Cost of Living” rose about 10%. Industrial production rose more than 45%.
Sumner goes on to impugn Skidelsky:
The “disappointing” results that Skidelsky mentions come from cherry-picking a few misleading data points.
All that seems very odd to me. If I were making an argument that conventional monetary policy doesn’t work in a liquidity trap, but that the traditional Keynesian prescription does, I’d start that argument with something very much like the sentences Sumner wrote right after stating “Unfortunately, Keynes and Skidelsky are wrong.”*
Using the graphing tool from FRED, the Federal Reserve Economic Database maintained by the St. Louis Fed, we can show the one year percentage change in both PPI (producer price index) and CPI (consumer price index) from January 1932 to December 1935.
Here’s what we see: after some massive deflation during the Great Depression, prices start to rise more or less when FDR took office. The annual percentage change in PPI peaked around 23% and change in February 1934, and the CPI peaked a few months later at about 5.6%.
Elsewhere, Sumner attributes that to:
We all know what happened next (well not exactly, but I’ll explain that in another post), so let’s jump ahead to 1933. FDR takes office in March, promising to boost wholesale prices back up to pre-Depression levels. He uses several tools, but the most effective was loosely based on Irving Fisher’s “compensated dollar plan.” Fisher’s plan was to raise the price of gold one percent each time the price level fell one percent. An obscure agricultural economist named George Warren was a big fan of Fisher’s idea, and sold it to FDR with all sorts of fancy charts.
And it worked.
Initially it worked better than any other macroeconomic policy in American history. But at first the policy’s success was mostly accidental, just a matter of talking the dollar down, not enacting Fisher’s specific plan. Nevertheless, prices immediately began rising sharply. Industrial production rose 57% between March and July, regaining over half the ground lost in the previous 3 1/2 years. Then in late July FDR decided to cartelize the economy and sharply raised wages (the NIRA) and industrial output immediately began falling. By late October FDR was desperate for another dose of inflation, and asked Warren to come up with a plan. They decided to have the US government buy gold at a price that would be continually increased in order to reflate the price level.
Sumner even helpfully tells us:
It was a very confusing plan, as they never bought enough gold to equate the government buying price with the free market price in London.
I agree that what Sumner describes is confusing. And yes, the times were desperate, and FDR was flailing around throwing all sorts of things against a wall to see what would work, but when I look at the graph above, and take into account the extremely rapid economic growth that took place during the New Deal era, I see a much simpler story.
- Aggregate demand was very slack when FDR took office.
- FDR showed up in Washington with a plan to start spending a lot of money and thus boost aggregate demand.
- The immediate effect was to convince factories they’d be running down their inventories. That boosted producer prices. It had a much smaller effect on consumer prices because everyone knew the gubmint was going to buy a heck of a lot more producer goods than consumer goods. (The government did buy some consumer goods for the various programs, plus there was a spillover effect, but as the graph clearly shows, the action was on the producer side.)
- After a bit of time, the public realized FDR wasn’t planning just a one-off, but rather a sustained program of purchases of industrial items. That led them to start using some of their idle capacity, which meant not just selling the fixed amount that was in inventory. The rate of price increases thus dropped.
- GDP increased at the fastest rate in the United States peacetime history since data has been kept. There was a big hiccup, of course, in 1937 when the government cut back on spending for a while.
By contrast, here’s Sumner explaining his theory:
There is a great deal of evidence that I won’t get into here that suggests the suspension of the gold standard in March 1933, and gradual devaluation between April and February 1934, almost certainly explain most of the increase in goods prices, stock prices, and industrial production during that period. But why? Not because it boosted our trade balance, which actually worsened as the rapid recovery pulled in imports.
Both Gauti and I believe that only the rational expectations hypothesis can explain these events. He focuses on how the regime change led to higher inflation expectations, and thus reduced real interest rates. I prefer to think in terms of specific policy signals sent as rising gold prices changed the future expected gold price, and hence the future expected money supply. I don’t see any non-Ratex explanation that can account for the extraordinary rise in prices and output during March-July 1933. Nominal interest rates didn’t change much, and open market purchases in 1932 (under the constraint of the gold standard) had accomplished little or nothing.
So…. his story requires the devaluation of the currency to worsen the trade balance, and rational expectations to cause a one time explosion in industrial prices and a rather smaller recovery in consumer prices. Rational expectations, however, that came an abrupt halt, at roughly the same amount of time one would predict companies might decide that demand will be sustained enough to start producing more rather than just selling off inventory sitting in warehouses. And his story doesn’t explain why growth was so much faster during the New Deal era than any other period of peacetime since the US began keeping data, nor why there was the big hiccup in 1937.
Sumner is essentially trying to tell a story about an unusual set of events, but his story seems to assume that most extraordinary events of the era (and what sets that era apart) kind of just happened to occur for no particular reason so he misses the big picture and ends up focusing on details. With all due respect to Sumner, I prefer to think the US economy is not Forrest Gump.
*I can imagine a “monetary” prescription that I think would help tremendously in a liquidity trap, but it doesn’t look at all like what was done in the 1930s, or what was done since 2007, or from what I can tell, what Sumner suggests. That can be a post for another time.
by >Mike Kimel
I’ve been writing about the relationship between tax rates and growth since I started blogging in 2006. A lot of those posts have focused on the quadratic relationship between tax rates and growth. That is, it turns out that if you take US data going back to when the BEA started keeping track, 1929, you can easily build a model of the following form:
% change in real GDP from t to t+1 = a + b*Top Marginal Tax Rate at time t
+ c* Top Marginal Tax Rate squared at time t
I have modestly referred to that as the Kimel curve. Now, it turns out that for most variations on that theme I’ve come up with, b is positive, c is negative, and both are significant at the 5% or 10% level. That allows you to find a top marginal tax rate that maximizes growth… which turns out to be somewhere between 60% and 70% depending on how the model is specified.
In this post I want to address a few criticisms by running two additional regressions with more or less the form. Parts of this may get a bit wonky but I’m going to keep it so that even if you’ve never done any statistical analysis, hopefully you’ll be able to follow the outcomes.
In the first regression, I’m going to account for a few additional facts:
1. By going with every single observation the BEA produces, I’ve been accused of “cherry picking.” So I’m going to throw in a dummy variable for Hoover.
2. I’ve been told the only reason growth was so quick during the New Deal was that there was a bounceback effect from the Great Depression… so I’m throwing in a dummy variable for FDR’s peacetime years (i.e., 33-41).
3. I’ve been told WW2 biases the results…. so there’s a third dummy for 1942-1944, the fast growing years in WW2.
4. I’ve also included two demographic variables: the percentage of Americans 35 to 44 and the percentage of Americans 45 – 54. The latter group tends to be the highest income group these days, but in an earlier era more focused on manual labor, those 35 to 44 might have been higher paid.
5. For grins, I threw in a dummy variable which is equal to 1 if the President is a Republican and 0 otherwise.
So… here’s what it looks like:
So what does it all mean? Well, this set of variables explains about 43% of the observed variation in growth rates over the period for which we have data (see the adjusted R2). There’s obviously room to improve the model, variables I’m not accounting for, etc.
The percentage of Americans 35 to 44 has a positive coefficient and is almost significant at 10%. We’re almost at the point where we’d be comfortable saying as that percentage increases, growth increases. The percentage of Americans 45 – 54 has a negative coefficient, but isn’t close to being significant.
Not surprisingly, the Hoover dummy is associated with economic shrinkage, FDR’s peacetime period is associated with positive growth, and 1942 – 1944 is associated with even faster economic growth.
The Republican dummy is not significant – any difference in the growth rate observed between the two parties can be explained by other factors. Which other factors?
Well, the top marginal tax rate and the top marginal tax rate squared are both significant – the former is positive and the latter is negative, which means they trace out the desired upside-down-U shape.
Oh… and the top of the curve happens when tax rates are at 64%. That is, the fastest growth rates seem to occur when the top marginal tax rate is around 64%. Now, I’ve had post after post on this topic, and the top of the curve always seems to occur in more or less in the same place. It isn’t a coincidence folks.
I’ll post results of the second regression in my next post in the series. That regression will focus on the period since Reagan took office and thus will only include data from 1981 to the present. What does it say? Well, a hint: if you don’t like the results shown in this post, you won’t be happy about that one either. But remember, I’m just the messenger. The data is what the data is, and if it isn’t showing what you think it should, its up to you figure out what’s wrong with the analysis or with the data, to pontificate wisely and inaccurately, to ignore the evidence, or to change your mind.
If anyone has a line on a good inequality series with annual data that goes back to 1929, please let me know. I’d like to drop it into the model. I’d also love a good proxy for regulation. Don’t be afraid to offer other suggestions for data to drop into the mix are welcome too. I’m like a DJ, I take requests, but it helps if you can point to whatever data you want me to use.
As always, if you want my spreadsheets drop me a line at “mike” period “kimel” (note – one m only in my last name!!!!) at gmail.com.
Thanks to Bill McBride for pointing toward the demographic data and m. jed for suggesting its use.