Inflation expections, income expectations & financial repression
The Federal Reserve Bank of San Francisco published a letter titled, Consumer Inflation Views in Three Countries, written by Bharat Trehan and Maura Lynch. The letter explores inflation expectations among consumers in the UK, US and Japan. Basically the story is that inflation expectations by consumers are tied to the level of oil prices and recent inflation. Policy adjustments by a central bank do not play much of a role in determining their inflation expectations.
The inflation expectations of consumers are important to evaluate the spending and wage demands of consumers. If consumers raise their inflation expectations, they would bargain for higher wages, only if they have power to do so. Labor has little power nowadays to bargain for better wages.
So what the letter from the FRBSF is missing is a comparison between what consumers expect of inflation and what they expect from their own incomes. Simply put, if I expect inflation to be 3%, but expect my own income to rise at around 0%, then I feel I am losing ground… and I will be less likely to spend money. Surely it makes more sense to spend money now since prices are rising faster than I can keep up with them, right? No… Spending more money now would make me feel even more insecure.
People tend to watch their spending because they feel vulnerable and uncertain about inflation. They hold onto their money because their incomes are not keeping up with inflation.
The very low interest rates are another factor in holding back spending by consumers. If I feel my income is growing at 1% and my savings are growing at less than 1%, then I feel even more vulnerable to 3% inflation and will hold onto my money to survive through the long-run… and I mean long-run for years and years, because labor/consumers do not see their plight changing anytime soon. They are concerned about saving for the future too.
The real problem with monetary policy is that there is no transmission mechanism to get liquidity into the hands of consumers. Consumers are dependent upon firms to raise their incomes, and firms have little incentive or weakness to substantially raise the incomes of labor.
So when inflation expectations are higher than the inflation target, higher than actual inflation and higher than income growth, it is a sign that consumers feel vulnerable and weak in comparison. Spending will be weak too.
If the Fed was to raise their interest rate, the return on savings for consumers would go up, and consumers would feel a bit more empowered to spend. Of course, the government would have to pay more to service its debt, but consumers would feel secure to spend more. Thus, we see a form of financial repression at work which has the effect of suppressing consumer spending to the advantage of the government and owners of capital.
Lambert
you analysis makes more sense to me… a survivor of the last big inflation in this country… than that of the usual economists. they seem to think we are all standing around with unlimited money anxious to buy “things” before the prices go up. in fact we are more likely to save what money we have so that we will have it to buy the things we really need.
but i am not so sure that higher interest rates would give us more confidence to spend. it is just as likely to give us more incentive to save. or at least a little less anxiety while we are saving, which is what we were doing anyway.
and isn’t the point of higher interest to attract “savings” to make more money available for investment?
coberly, as also a survivor of that last big inflation (late Carter years), i’ll disagree with you and edward on “People tend to watch their spending because they feel vulnerable and uncertain about inflation. They hold onto their money because their incomes are not keeping up with inflation.”
that’s just the opposite of what i did; i tried to buy anything i could in advance of the price increases i expected were coming, rather than save money which i perceived to be losing value…and i still have an entire storage room full of sfuff i may never use to show for it…
Rjs
i think you must have been richer than i was. as seems to be the case with the usual economists… who also think the unemployed were just standing around waiting to be offered more than they were worth. thus giving rise to the NAIRU fallacy.
doubt that i’d have been considered richer than you or anyone, coberly, as my only income at that time came from what produce and honey i could sell to local health food stores, although i did have some savings left from a stint as a systems troubleshooter in the early 70s…i just got into a doomer / resilience mentality back then, about 40 years before it became fasionable…and the economic implications of my behavior was the farthest thing from my mind…
Hi Coberly,
Have you watched the videos on youtube on Behavioral Economics by Dan Ariely. The videos are titles… Predictably Irrational. I used to teach this material when I taught in Chile.
Here are some links…
Things are relative
Expectations
Decision illusions
After looking at those videos, re-consider what a person feels and expects seeing the return on their savings go so far down, and realizing that the low return is going to be around a long time.
They will feel like they have less money, not more. Thus they will spend less. It’s an illusion created by the low Fed funds rate compiled by meager increases in incomes.
Once you put monetary policy into the context of psychology, the models change.
“If the Fed was to raise their interest rate, the return on savings for consumers would go up, and consumers would feel a bit more empowered to spend.”
But interest income is one of the most unequally distributed forms of income that there is.
According to Edward Wolff, in 2007 the top 1% in net wealth held 34.6% of the net wealth. It’s true they only held 20.2% of the demand, savings and time deposits, money market funds and certificates of deposit (the bottom 90% held 42.3%). But they also held 60.6% of the corporate bonds, government bonds, open market paper and notes (the bottom 90% only held 1.5%) (Table 9):
http://www.levyinstitute.org/pubs/wp_589.pdf
And according to the IRS, and data supplied by Emmanuel Saez, approximately 45.7% of the taxable interest income went to the top 1% in income in 2010. For comparison the same data shows that the top 1% in income had 19.9% of all taxable income including capital gains.
Similarly, interest payments on debt are one of the most unequally distributed forms of expenditures that there is. The top 1% in net wealth only owe 5.4% of the debt, whereas the bottom 90% are blessed with 73.4% of the debt. Thus the debt to income ratio of the top 1% is only 39.4% in whereas for the middle 60% it is 156.7%. (See Tables 7 and 9.)
An increase in the effective interest rate decreases the cash flow for households which are net debtors while increasing it for net creditors. However, the usual assumption is that net debtor households are more sensitive to changes in cash flows arising from changes in interest rates than net creditors. This is because net debtor households are less likely to have significant financial assets to help them maintain their spending patterns in the face of a change in net income. This suggests that the net effect of a increase in the effective interest rate is likely to to decrease aggregate spending and, by the same reasoning, an decrease in the effective interest rate will have the reverse effect.
The Cash Flow Channel of the Monetary Transmission Mechanism (MTM) was found to be an important factor during the Great Depression by Frederic Mishkin. A decline in consumer cash flow increases the risk of financial distress, which reduces the desire of consumers to hold durable goods or housing, thus reducing spending on them and hence aggregate output. Under the cash flow channel it is not the lenders’ unwillingness to lend which causes spending to decline but the consumers’ willingness to spend.
http://www.jstor.org/discover/10.2307/2118664?uid=3739592&uid=2133&uid=2&uid=70&uid=4&uid=3739256&sid=21102523337637
The Household Balance Sheet and the Great Depression
Mishkin, Frederic S.
December 1978
Abstract:
“This paper focuses on changes in household balance sheets during the Great Depression as transmission mechanisms which were important in the decline of aggregate demand. Theories of consumer expenditure postulate a link between balance-sheet movements and aggregate demand, and applications of these theories indicate that balance-sheet effects can help explain the severity of this economic contraction. In analyzing the business cycle movements of this period, this paper’s approach is Keynesian in character in that it emphasizes demand shifts in particular sectors of the economy; yet it has much in common with the monetarist approach in that it views events in financial markets as critical to our understanding of the Great Depression.”
Lambert
you seem to be agreeing with me, but apparently missed that i was agreeing with you. this happens to me a lot.
in any case i don’t have the means to watch u-tube. but since i studied this stuff in graduate school, i suspect i already know what it will say.
Rjs
if you had enough money to buy stuff, you had more than i did. maybe economists need to study the behavior of people who have less money than their own reference group. one thing that i have thought could help them is to realize that their model may apply to “business man”, but almost certainly does not apply to “ordinary worker/consumer.”
Coberly,
Sorry, i knew we were on the same page, I was offering a different approach to look at it. Sorry if it appeared that I thought you were disagreeing with me…
Mark,
Think of the psychology of the consumer. Even the paper from the FRBSF stated as much that the consumer was being irrational on some points.
The top 1% do not make the same errors in judgement about inflation. The paper talks about that. But why then do consumers make errors. My view is that you have to put yourself in their minds and see what information is available to them, how they compare it, how they put it into context and how they react to it. The top 1% uses market analysts that don’t make the same errors.
The consumer has to put their life in context… and right now the signals are showing them that they have to be careful about their spending. Low returns are savings is one of those signals.
It seems irrational but look at the money market model… The theory goes like this… if you lower interest rates, demand for liquid money goes up, people want to hold more money… then the theory makes an irrational conclusion… since people are holding more money they will spend it…
No… they simply hold more money and try not to spend too much. and then it is compounded by healing their balance sheets as you point out and helping unemployed family. and the FRBSF paper points out that incomes are stagnating too.
The point is that consumer spending is not rising even though inflation expectations are relatively higher. The psychology of the consumer contradicts the conclusion of the money market model.
By the way, do you see financial repression in the US with low savings rates and low income growth? Owners of capital and the government are being subsidized with extra low cost money at the expense of returns for households. Do you agree with that?
lambert
no need for “sorry”. miscommunication is common. i would disagree that low income people are “irrational” even given that they have limited information. they simply have different expetations, and different tolerance for risk than people with more money.
the people who are irrational are the economists who regularly assume that their favorite variable explains everything even when it obviously doesn’t.
Coberly,
I am just going to quickly agree with you… no if ands or buts.
Lambert
It’s generally safer that way.
“It seems irrational but look at the money market model… The theory goes like this… if you lower interest rates, demand for liquid money goes up, people want to hold more money… then the theory makes an irrational conclusion… since people are holding more money they will spend it… No… they simply hold more money and try not to spend too much.”
The interest rate is determined not only by liquidity preference.
It is also determined by the supply of and demand for savings,
For example, suppose that desired savings and desired investment spending (as well as durable goods expenditures etc.) are currently equal, and that tighter monetary policy causes the interest rate to rise. Desired investment will fall and desired savings will rise. This will lead to economic contraction which drives down income. And since some of the decline in income would have been saved, and assuming that investment demand doesn’t fall by as much, a sufficiently large decline in GDP will restore equality between desired savings and desired investment at the new interest rate.
Meanwhile, people deciding how to allocate their wealth are making tradeoffs between money and other financial assets. The higher the interest rate, the more people will skimp on liquidity in favor of higher returns. However, a lower level of GDP will mean fewer transactions, and hence lower demand for money, other things being equal. So lower GDP will mean that the interest rate needed to match supply and demand for money must fall.
Assuming that the savings-investment relationship is fixed, and the liquidity-money relationship is changed by tighter monetary policy, the end result is that the interest rate will be higher and GDP will be lower.
This is standard Econ 102 and comes straight out of Keynes’ General Theory:
http://rbarch.people.wm.edu/answers/Image16.gif
“By the way, do you see financial repression in the US with low savings rates and low income growth? Owners of capital and the government are being subsidized with extra low cost money at the expense of returns for households. Do you agree with that?”
No.
By definition, financial repression benefits debtors, the borrowers of financial capital, at the expense of creditors, the owners of financial capital. It is governments and net debtor households that benefit from low interest rates. The owners of financial capital are hurt by low interest rates.
Why do you think they are called Rentiers?
Mark,
The interest rate in the money market is now exogenous. The Fed sets it, like money supply is considered exogenous. The Fed has pushed the interest rate so low in order to make people dis-save and to encourage investment.
But there is a problem, demand has fallen to the point of constraining investment incentives and holding back real GDP growth. So yes people will spend less money due to slow real GDP, but that is part of the demand constraint.
The key to demand is to get consumers feeling more secure about their money, either raising return on their savings or raising incomes, or even lowering inflation. This is the strange world we live in now.
You might know that I break the money market into two markets, one for owners of capital and one for labor. There really needs to be equilibrium between the two markets, but the Fed is distorting that equilibrium in favor of capital. Low interest rates suppress demand by labor as is seen by the money demand curve shifting left in the labor money market model in the absence of inflation.
A rise in interest rates would accompany a growing real GDP holding money supply to labor constant.
Monetary policy is more supply-side oriented through trying to raise investment even though business is up against a demand limit. Policy needs to be demand-side oriented to get consumers to feel secure about spending. Even productivity is constrained by demand. If demand can increase, then investment will respond.
“The interest rate in the money market is now exogenous. The Fed sets it, like money supply is considered exogenous. The Fed has pushed the interest rate so low in order to make people dis-save and to encourage investment.”
The Fed targets the fed funds rate, not all interest rates.
Interest rates are also low because income expectations are low.
“The key to demand is to get consumers feeling more secure about their money, either raising return on their savings or raising incomes, or even lowering inflation. This is the strange world we live in now.”
The world is not so strange that any increase in the rate of interest that middle class househols receive on their demand, savings and time deposits, money market funds and certificates of deposit will offset the increase in interest that middle class households will have to pay on their mortgages, car and consumer loans. And it isn’t so strange that lower rates of inflation will not mean increasing the real value of debt. The only people who will be pleased by this outcome are the owners of financial capital.
“You might know that I break the money market into two markets, one for owners of capital and one for labor. There really needs to be equilibrium between the two markets, but the Fed is distorting that equilibrium in favor of capital. Low interest rates suppress demand by labor as is seen by the money demand curve shifting left in the labor money market model in the absence of inflation.”
You’re making this needlessly complicated. Households that are net debtors benefit from lower interest rates and households that are net creditors are hurt. This is true even if corporations are net debtors and are predominently owned by the net creditor households.
“Monetary policy is more supply-side oriented through trying to raise investment even though business is up against a demand limit. Policy needs to be demand-side oriented to get consumers to feel secure about spending.”
It’s not clear to me that a lack of consumer spending is the problem. Between C, I and G, consumption is the only thing that is at record levels, and consumer durable expenditures have been soaring, and are more or less back to trend:
http://research.stlouisfed.org/fred2/graph/?graph_id=148223&category_id=0
Hi Mark,
I found what you said here to be an important idea…
“Interest rates are also low because income expectations are low.”
and I am thinking that low interest rates imply a lower real GDP in the money market model when many consumers are short on liquidity (money supply). A lower real GDP would imply lower income expectations. It’s like going around in a viscous circle.
I see that a lack of consumer spending is not a problem, unless you are an economist that expects real GDP to return to pre-crisis levels. To me, consumer spending reflects the new sub-optimal state.
I see in the graph link you gave that C is moving up just as real GDP is moving up. To me it is a new sub-optimal level. I hate to call it an equilibrium though.
About breaking households into net debtors and net creditors, my view is that there is less money liquidity (supply) in the labor money market due to fallen labor share. There is less money liquidity among net debtor labor and net creditor labor. There is more liquidity in the capital money market. The constrained liquidity among labor is constraining investment and spending. The key is to increase liquidity among labor who are major consumers. You mentioned the transmission mechanism. The transmission mechanism from capital to labor is not working.
Sadowski
“The world is not so strange that any increase in the rate of interest that middle class househols receive on their demand, savings and time deposits, money market funds and certificates of deposit will offset the increase in interest that middle class households will have to pay on their mortgages, car and consumer loans. ”
maybe it is. these different relations to debt/interest occur at different times of life. my house and car are paid for and i don’t need consumer loans. on the other hand an interest rate higher than five one hundredths of a percent on my savings would sure make me feel more secure in my retirement.
@Edward,
Labor income comes from wages and salaries, Capital income comes from business income, rent, interest and dividends.When it comes to the distributive effects of interest I don’t think that distinction is nearly as important as whether you are a net creditor or a net debtor.There is only one money market.
@Coberly
“my house and car are paid for and i don’t need consumer loans.”
I hate to tell you this Coberly but in my book that makes you a Rentier, and I don’t lie awake at nights worrying about whether the bond coupons you’re clipping are up to snuff.
Also, I have a sneaking suspicion if your interest income were boosted you won’t be going out on a wild spending spree.
Sadowski
i most definitely do not mean to sound unfriendly, but it sounds to me like you are one of those people … most people… who think in pre fabricated concepts and not so much in terms of what someone like me would call reality. I don’t really know what a rentier is, but i made my money by working, and i managed to save enough to retire. my retirement would be less parlous if i could earn a reasonable rate of interest without excessive risks.
Mark,
Your statement of one money market makes me remember my years in Chile and Latin America.
The supply curve is determined from the labor market… there is seen one labor market in the model. But when you travel through Latin America, you hear a common word… “marginalizados”. marginalized. The labor market just does not have room for everyone. Many go years with no chance for a real job. Many people simply don’t exist within the theoretical analysis of the economy.
You may say there is one money market, but then I wonder who is being marginalized from that market, how many are being left out and what the consequences are for the economy. And then I try to understand the market that those people live in.
Janet Yellen says that she will work for all people… but many people are marginalized from her range of influence. There is not just one money market for everyone. Yet low interest rates are affecting people marginalized from “the” money market.
There is a problem growing of more and more people being marginalized. We need models to know who is benefiting and who is not. Society is getting more and more fractured and the economy has deteriorated.
@Coberly,
What you call reality is not the reality of most people.
According to the most recent Survey of Consumer Finances only about one in five households own a house without a mortgage. True, households where the age of the head is 65-74 own a house without a mortgage at about a 40% rate, but according to the CDC of people born in 1940-1950 only about two thirds even live to the age of 65, so I imagine there is a good deal of overlap.
Among all households, only about one in eight own a CD or a bond of any kind. Among households where the head is 65-74 the rate of ownership only rises to about one in five. Most people don’t worry about their interest income because very few people earn anything beyond the trivial amount that which accrues on the few thousand dollars worth held in their checking and savings accounts.
@Edward,
True, according the Survey of Consumer Finances households in the bottom two quintiles of income are less likely to hold any form of debt on average, but they are also less likely to hold any form of interest earning asset. By far the most common form of debt held by a households in the bottom quintile is installment debt, in particular car loans. The median amount of installment debt held by a household in the bottom quintile is $7,600. In contrast the most common form of interest earning asset held by a household in the bottom quintile is a checking or savings account. The median amount held in checking or savings accounts by households in the bottom quintile is $700. It’s easy to see that any increase in the rate of interest would hit such households very hard.
Now, from the Flow of Funds we know that households owe about $12.9 trillion in interest bearing debt. Since there are 115 million households and according to Edward Wolffe the top 1% in net wealth hold about 5.4% of debt this means a household in the top 1% of net wealth owe an average of about $600,000 in interest bearing debt. It’s hard to say what form this debt is but I’ll guess that a disproportionate amount of it is in the form of mortgages on non-primary residences and in unsecured credit.
Furthermore households own about $9.0 trillion in demand, savings and time deposits, money market funds and certificates of deposit and $5.4 trillion in corporate bonds, government bonds, open market paper and notes. According to Edward Wolffe the top 1% in net wealth hold about 20.2% of deposits and 60.6% of financial securities so this means that the top 1% in net wealth own an average of $1.58 million in deposits and $2.85 million in financial securities. It’s easy to see that any increase in interest rates would line their pockets even more than they already are.
The Federal Reserve Bulletin on the Survey of Consumer Finances:
http://www.federalreserve.gov/pubs/bulletin/2012/pdf/scf12.pdf
The CDC Life Tables:
http://www.cdc.gov/nchs/data/nvsr/nvsr59/nvsr59_09.pdf
The Flow of Funds Level Tables (See L.100):
http://www.federalreserve.gov/releases/z1/Current/z1r-4.pdf
The American Community Survey for the number of households:
http://www.census.gov/prod/2013pubs/p20-570.pdf
I already linked to Edward Wolffe in my first comment.
Sadowski
i wouldn’t know about the reality of most people. i suspect that most people live in a fantasy, just as you do. Only your fantasy is called academic facts and figures. Statistical man. Whatever “most” people have done with their money over their lifetime, this person saved enough to retire. this person’s reality is that with interest rates as low as they are, his savings are not worth as much as he hoped. this person also does not believe that the world owes him a living, but if interest rates are being held down because the Federal Reserve Board is living in a fantasy, or because the Bankers created a reality in which people are afraid to spend or invest, then this person will do what he can…. precious little… to suggest that the fantasy called economic theory needs to start a new chapter with some new ideas… even new fantasies might help.
So I hope you won’t despise me, and call me a “rentier” because instead of buying that new car i put my money in the bank. Heck, I thought that’s what Uncle Milty wanted me to do… the reason he wanted to take away my social security, which fortunately, so far, his friends have not been able to do, but the Democratic President, you know, the guy with the Nobel Peace Prize, is now on their side. So I am awaiting events.
Mark,
Sorry for replying late… much to do on a day off.
Your analysis with numbers is extremely helpful in this issue. You make a good case that higher interest rates would hurt lower incomes and benefit higher incomes.
Then let me ask you some questions…
The Fed has to hit a positive rate target at the natural level of output. Nick Rowe wrote about this….
http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/08/is-this-a-liquidity-trap.html
The Fed calculates that the natural level of output is near $17 trillion (real 2009 $$).
If the natural level of real output is close to $16 trillion instead of $17 trillion, how would you change monetary policy? Would you change monetary policy if the target all of a sudden looked much lower?
The other question involves inflation.,,
Which of these four options affects inflation more at the moment?
money supply, inflation expectations, income expectations or consumers paying lower prices.
“The Fed has to hit a positive rate target at the natural level of output. Nick Rowe wrote about this….”
I have to caution you here. Nick Rowe is doing strange things to his IS-LM diagram which he carefully justifies. He’s also conflating short run with long run interest rates which is common.
I think it would be nice if the fed funds rate were positive when the economy is at potential because that would simplify monetary policy greatly, but it is not essential.
“The Fed calculates that the natural level of output is near $17 trillion (real 2009 $$). If the natural level of real output is close to $16 trillion instead of $17 trillion, how would you change monetary policy? Would you change monetary policy if the target all of a sudden looked much lower?”
To be clear, the Fed does not compute estimates of potential GDP, the CBO does. The BEA recently completely revised its historical estimates of GDP and consequently the CBO is going to revise its estimates. In August it said those estimates would be ready by November but November is over and they are still not available.
NGDP was $16.9 trillion in 2013Q3. My guess is that when the CBO’s estimates come out it will show potential GDP was $17.9 trillion in 2013Q3.
If the economy were above potential then that would justify tightening monetary policy. But given unemployment is still very high and inflation is well below the official target, I seriously doubt that is the case.
“The other question involves inflation.,, Which of these four options affects inflation more at the moment? money supply, inflation expectations, income expectations or consumers paying lower prices.”
To be frank, this question is strange. Are you asking me which of these four factors affects inflation? Consumers paying lower prices is the definition of lower inflation so it cannot be a causal factor (it makes no sense).
With respect to the other three…
1) Money supply is influenced by monetary policy and it is statistically cointegrated with NGDP. NGDP is for intents and purposes AD, so all other things being equal the rate of change in NGDP determines the inflation rate. Thus monetary policy, by influencing money supply and NGDP, helps determine the inflation rate.
2) Inflation expectations is included as a variable in the New Keynesian Phillips Curve which is an integral part of the DSGE models many central banks use today. (And to be technical, inflation expectations is proxied by fitted values derived by regressing future inflation on various instrumental variables.) But the NK Phillips Curve has a generally worse empirical record than the older Gordon Triangle Phillips Curve which simply includes the unemployment rate, past inflation and supply side factors as variables.
3) The University of Michigan does a survey on household nominal income expectations. I’ve done some statistical analysis with this survey and among other things I find NGDP Granger causes nominal income expectations implying people’s expectations of future incomes is largely determined by their present incomes.
In short, from a policy perspective monetary policy ultimately determines the inflation rate. From an empirical perspective the old Gordon Triangle Phillips Curve (the unemployment rate, past inflation and suplly side factors) fits inflation very well.
Lambert, Sadowski
i’d caution you to beware of this kind of thinking:
“According to the most recent Survey of Consumer Finances only about one in five households own a house without a mortgage. True, households where the age of the head is 65-74 own a house without a mortgage at about a 40% rate, but according to the CDC of people born in 1940-1950 only about two thirds even live to the age of 65, so I imagine there is a good deal of overlap.
“Among all households, only about one in eight own a CD or a bond of any kind. Among households where the head is 65-74 the rate of ownership only rises to about one in five. Most people don’t worry about their interest income because very few people earn anything beyond the trivial amount that which accrues on the few thousand dollars worth held in their checking and savings accounts.”
This “ignore the details” analysis would earn you an F on a freshman physics test.
You seem to be saying that since “only about one in five households…” you can ignore 20% of the population. because, i guess, we all know that what happens to 20% of the population cannot affect GDP. and worse, we don’t give a damn about what only affects 20% of the population.”
Mark, It will turn out that the Fed rate will be at the ZLB when the natural level of GDP is reached. It will be a strange time. It seems Paul Krugman wrote some about this today…
http://krugman.blogs.nytimes.com/2013/11/29/on-the-importance-of-little-arrows-wonkish
He gives a new model for the natural rate of interest.
In his graph, if the natural level of GDP is further to the left, WNR is actually further to the left and MP won’t change because the Fed is expecting a higher natural level of GDP. The result is that A goes up higher.
So I would say that it should be essential for the Fed funds rate to be positive at the natural GDP level.
By the way, I appreciate your use of NGDP.
And I am looking forward to the potential GDP updates in 2009 dollars. $17.9 potential GDP does not sound good. Does the CBO realize that there is a demand constraint upon potential?
You know I base my equations upon labor share, which has fallen 5% since the crisis. So far the curves are bending as these equations would predict…. like capacity utilization stalling out, lower trend of real GDP, higher unemployment, persistent ZLB, lower potential GDP, low inflation, stalled productivity against an effective demand limit…
Dump what I said about the graph from Krugman’s blog… I was seeing an IS-LM type model with output on the x-axis. I slept way too much before I read it.
The graph is showing that if inflation perks up, the signal is that the natural rate of interest has risen above the interest rate. The Fed would then get ready to tighten.
The problem with the graph is that inflation is not going to perk up like that. Income growth is not going to support price increases.