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Another Version of the Effective Demand Monetary Rule with comment on Secular Stagnation

I have been writing about the Effective Demand rule for monetary policy lately. The version that I have been showing uses a labor share anchor, which is a projection of where labor share will be at the natural limit of the business cycle. Labor share has always tended toward its labor share anchor at the end of a business cycle. So the labor share anchor is a measure of the eventual potential in the economy.

Some people may not feel comfortable with the anchor as it is estimated from a trend line of effective labor share. I have another version of the Effective Demand Rule that uses the labor share data that is released by the US Department of Labor: BLS… without converting it to an anchor.

Comparing Graphs of Each Version.

First graph uses the anchor representing the eventual natural potential. Second graph uses the trending effective labor share. (Effective labor share = Non-farm labor share: Business sector * 0.762) The second graph is a more straight-forward way to measure the base nominal interest rate for an economy. They both can be produced on a monthly basis using monthly data for capacity utilization, unemployment and inflation.

update ED monetary rule

update ED monetary rule w els monthly rev765a

Since the crisis there is little difference between the two graphs. Yet you will notice some differences. For example, between 1998 and 2004, monetary policy is seen as tighter before and after the 2001 recession. The economy was building slack after 1998 and a lower Fed rate would have been proper. The version above using trending labor share shows that better. Labor share ultimately fell (after 2001 and especially after the crisis) and ate up some of that accumulating slack.

Comment on Secular Stagnation

What some call secular stagnation is the process of labor share falling to eat up excess slack caused by competitively lower labor shares overseas, lower overhead costs overseas and new productive technology. But in actuality, the excess slack no longer exists while labor share stays low. If you do not understand this, you will still see the slack, like Krugman, Summers, the Fed and others.

Should the fall in labor share have been temporary? Did it become an undesired global downward spiral? I think so… If advanced countries could now coordinate a reversal of falling labor share, the aura of secular stagnation would dissipate like a morning fog.

Note on Accuracy of Effective Demand Monetary Rule

Note: An important thing to realize in the Effective Demand Rule equation is that the only value of labor share that works… is the basic “effective” labor share value used to determine Effective Demand. Thus the accuracy of the Effective Demand Rule (when compared to the actual Fed rate) supports the calculation of the effective labor share, and thus the projection of the Effective Demand limit.

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Jump in Base Fed Rate would continue for July…

What would the Fed funds rate be if we were in normal times? Basically, what would the Fed funds rate be if we used a rule instead of the discretionary policy being used by the Fed?

I use my Effective Demand rule using the CPI (less food & energy) data released just this morning. My ED rule has an advantage over other rules that use GDP numbers because they have to wait 3 months for the GDP numbers. I do not. So here is the monthly update of where the Fed’s base nominal interest rate would be as if we were in normal times…

update ED monetary rule recent

The 3rd quarter of 2014 so far is starting out by reinforcing the jump up in the ED “rule” rate seen in 2nd quarter 2014. The ED rule is giving the same rate of 3.5% for July 2014. Let me show you how this is calculated.

Here is the Effective Demand rule…

Effective Demand Fed Rate Rule = z*(TFUR2 + LSA2) – (1 – z)*(TFUR + LSA) + inflation target + 1.5*(current inflation – inflation target)

z = (2*LSA + NR)/(2*(LSA2 + LSA))

TFUR = Total Factor Utilization Rate, (capacity utilization * (1 – unemployment rate)), 74.3% for July 2014.
LSA = Effective Labor Share Anchor is currently 74.5.
NR = Natural real rate of interest is assumed to be 1.8% currently.
Inflation target = 2.0%
Current inflation (CPI less food & energy) = 1.855% in July 2014.
1.5 coefficient = To give the Fed rate leverage when inflation gets off target. Fed rate would change 1.5x more than inflation is off target.

We first determine the z coefficient…

z = (2 * 74.5% + 1.8%)/(2*(74.5%2 + 74.5%)) = 58.00%

Then we determine the TFUR for July 2014…

TFUR = capacity utilization * (1 – unemployment rate)
TFUR = 79.2% * (1 – 6.2%) = 74.3%

Now we use the Effective Demand rule to determine the base nominal rate…

58%*(74.3%2 + 74.5%2) – (1 – 58%)*(74.3% + 74.5%) + 2.0% + 1.5*(1.855% – 2.0%) = 3.5%

The ED rule worked very well for decades before the crisis. We get an idea of the twilight zone in which monetary policy now finds itself. The Fed just does not understand the unusual shift in Effective Demand which has occurred in the last decade.

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Holy Ministry of Truth Batman!

Lifted from comments on Financing Social SecurityBruce Webb comments on Social Security prpaganda:

Jim, the problem is that those people with “government, financial, business
experience” who are promoting the message “No check for you!” to millennials
know full well the numbers behind the following equation:

No Check for You = After Trust Fund Depletion a Remaining Check only 15% BETTER
in Real Basket of Goods Terms than Similarly Situated Retirees Today

Yes you read that right. Under current projections if nothing is done future
retirees will experience a cut from a check about 30% larger in real goods terms
than retirees get today down to a check maybe only 12-15% larger. And this
taking into account a continuation of current income inequality trends and
continuing improvements in mortality.

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Blackie, in Wantagh, NY [Sweet dog still needs a home. 8/23]

I see so many listings about older dogs whose owner can no longer care for him or her, usually because of finances. I just received this sweet, touching email notice,* from Hempstead Animal Shelter in Wantaugh, NY (Nassau County), via, and thought I’d pass it along.

*Corrected link, thanks to Noni Mausa.  A note has been added to the listing since earlier today saying: “URGENT: This animal could be euthanized if not adopted soon.


 UPDATE: Yves Smith has now linked to this post, under the topic “Class Warfare”:

Blackie, in Wantaugh, NY Angry Bear. Another sad reminder of the costs of the crisis.

Metro New York City is a huge place. There must be many people who can, and would be happy to, adopt this sweet dog. So thanks, Yves, for publicizing my post.  And for making the point you make.


SECOND UPDATE: Blackie was adopted today!  See the Comments thread below. 8/20

THIRD, SAD, FRUSTRATING UPDATE: Please see my second post on this, above.

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A closer look at the Effective Demand Monetary Rule

We see more talk now about how the Fed may have to raise its base overnight rate (Fed funds rate) faster than planned. Data is coming out that points to a need to raise the Fed funds rate.

Last week I posted this graph showing the Fed funds rate in comparison to the “Effective Demand” rule I developed for determining the base nominal rate for any central bank. (link) My ED rule has trended very well with the actual Fed funds rate over time.

update ED monetary rule cb

Just recently at the right (2nd quarter 2014) we see that the ED rule is calling for a quick rise in the Fed rate. It may be a blip that will correct downward in the next quarter, but maybe not. CPI inflation (less food & energy) jumped up in the 2ndQ-2014. Was it a blip? We will watch core CPI over the next few months to know.

The ED rule I use does not estimate “potential”, like the Taylor rule which depends on an estimate of potential GDP or potential unemployment (NAIRU). The ED rule I developed uses real data… With only capacity utilization, unemployment, labor share and a natural real rate, I match the Taylor rule. I don’t even estimate a NAIRU in my rule.

Part of my ED rule in blue leaving out current inflation and the inflation target. The corresponding portion of the Taylor rule in red.

z*(TFUR2 + LSA2) – (1 – z)*(TFUR + LSA) = NR + a*(y – y*)

z = (2*LSA + NR)/(2*(LSA2 + LSA))

TFUR = Total Factor Utilization Rate, (capacity utilization * (1 – unemployment rate))
LSA = Labor Share Anchor which stays fairly stable throughout a business cycle.
NR = Natural real rate of interest
a = Estimated coefficient from Taylor rule for weighting slack in “potential” output. Debate exists over correct value.
y = Real GDP for Taylor rule.
y* = “Potential” Real GDP for Taylor rule.

The corresponding portion of my ED rule (blue) does not have the problems trying to estimate “potential” GDP nor even the correct value for the “a” coefficient. Paul Krugman and John Taylor, for example, do not agree on the value of “a”. My ED rule has no room for such a debate as there are no coefficients which are statistically obtained. You just get the data and arrive at the Fed funds rate.

I like my Effective Demand rule much better than the Taylor rule because “potential” is not estimated. And it is clear that estimating potential is a problem for economists.

An “Effective Demand” understanding of how labor share limits the utilization rates of labor and capital is all that is needed. I would say that my ED rule implicitly incorporates the dynamics of “potential” GDP. As you can see in the above graphs, my rule did very well never having to use estimations of “potential”.

The Taylor rule and the ED rule both have to estimate the natural real rate. The graph above estimates a natural real rate of 1.8% since the crisis. But what if Larry Summers is right and the natural real rate is lower? Here is the graph with an estimate of a 0.5% natural real rate. My rule stills shows that the Fed funds rate would be around 2% now.

update ED monetary rule 05NR

The Fed is following a discretionary policy which allows them to keep the Fed funds rate below a higher rate determined by a rule. But if the Fed has such problems estimating “potential”, their discretion could well be misguided.

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Migration patterns between US states

Via Daily Kos’s David Jarman comes an interactive graph that offers an intriguing visual experience for migration numbers between states for 2012, designed by Chris Walker and offered here.  There is a 10,000 person cut off point in the visual, so three states are left off, but of course they had population movement.  10,000 was an arbitrary decision but my guess would be that the chart would become visually overwhelming if it was a 2,000 person cutoff, for instance.

Not to take away from the innovative presentation, I found the interpretations by Chris Walker himself premature to the task of interpreting the results,  his data being just a start.  To jump to conclusions one prefers or considers obvious is often the case in comments.  Such is often the case with raw numbers. Jarman adds a layer of of needed interpretation for the Texas/California pronouncements..

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Getting people’s attention by screaming

Lifted from Robert Walmann’s…

Paul Krugman wrote:

The answer all the deficit-panic types offer is basically that we must cut future benefits. But why, exactly, is that something that must be done immediately? If you state the supposed logic, it seems to be that to avoid future benefit cuts, we must cut future benefits. I’ve asked for further clarification many times, and never gotten it.

I am not a deficit-panic type demanding immediate cuts to future benefits, so I can’t answer the question. That won’t stop me from trying. I can think of three answers.

The first is not 1) “Greece Greece I tell you.” Krugman understands this argument. In fact I am quoting him putting words in the mouth of a straw man. He once believed something like the non parody version of this. This is one of the errors he pulls out when he is accused of not admitting errors. The short reply is “Japan Japan I tell you.” The long one is to ask people to explain how the USA could run out of dollars. Greece can go bankrupt because it borrowed in Euros. California can and Argentina did default because they borrowed in dollars. The US Federal government can’t run out of dollars. The true concern isn’t for the debtor (US Treasury) but the creditors who don’t want the value of their dollar denominated assets to be inflated away.

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Head scratching use of water

Bottled water is not a significant part of water use compared to agricultural use, but certainly has a heavy footprint in plastic bottles. I believe tap water and well water is pretty safe to drink throughout the US, so what is the appeal??

California is suffering through a  record drought. Water is being rationed and its usually  fertile agriculture industry is suffering.

Meanwhile, someone in Minnesota or Kentucky or Maryland may be drinking a bit of California’s precious commodity.  Mother Jones reported this week that at least four major bottled water companies—Aquafina, Dasani, Crystal Geyser and Arrowhead—use water from California, either ground (spring) water or tap water. Aquafina and Dasani both bottle and sell treated tap water, while Crystal Geyser and Arrowhead use spring water.

That’s partly because the brands are based or have plants there. In addition, California is the only western state that doesn’t regulate or manage groundwater use.

Julia Lurie reported that while the amount of water used to make bottled water pales in comparison to the 80 percent of California water used in agriculture, the idea that water is being directed away from the drought-stricken state is head-scratching.

“Despite the fact that almost all U.S. tap water is better regulated and monitored than bottled, and despite the hefty environmental footprint of the bottled water industry, perhaps the biggest reason that bottling companies are using water in drought zones is simply because we’re still providing a demand for it: In 2012 in the U.S. alone, the industry produced about 10 billion gallons of bottled water, with sales revenues at $12 billion,” she wrote.

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