Relevant and even prescient commentary on news, politics and the economy.

Overlay of Effective Demand rule upon Taylor and Rudebusch rules

Tim Duy posted a graph of various rules to determine the base nominal interest rate of the Federal Reserve. Here is the graph that he posted. (link)


The graph includes versions of the Taylor rule and the modified Taylor rule used by Glenn Rudebusch at the Federal Reserve Bank of San Francisco.

Now I will overlay my effective demand rule (orange line) on top of his graph. (link to equation)

overlay of rules

The effective demand rule tracks a similar path to the other rules. The other rules use the output gap (Taylor) and the unemployment gap (Rudebusch).  Since the output gap is prone to errors of measurement, the ED rule takes a different approach, by comparing the composite utilization of labor and capital against an effective labor share.

The ED rule assumed a 3.0% natural real rate up to the 2001 recession, a 2.5% natural real rate up to the crisis and a 1.8% natural real rate since the crisis.

Currently, the Rudebusch rule is giving the same Fed rate as the Effective Demand rule. They are all in positive territory roughly averaging 2.6%.

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Full D.C. Circuit Court Will Rule on PPACA Subsidies

King v. Burwell [Cert] and Halbig v. Burwell) arrived at the DC COA in hopes of defunding (Ted Cruz’s top priority dream) the PPACA. Initially, a 3 judge panel ruled 2-1 striking down the funding of the PPACA based upon an earlier IRS interpretation of PPACA Section 1311 stating “Exchanges established by States.”

Section 36B of the Internal Revenue Code, which was enacted as part of the Patient Protection and Affordable Care Act (“ACA”), authorizes federal tax credit subsidies for health insurance coverage that is purchased through an “Exchange established by the State under section 1311” of the ACA.

The Obama administration asked the DC COA “to consider en banc the legality of subsidies being given to consumers to help them afford health care insurance, if they shop for it at a federal marketplace (“exchange”).” 11 judges voted in favor of hearing the case en blanc (I can only guess who voted no). It is just a guess; but when 11 judges vote yes to hear a case, the likelihood of the decision is usually favorable. In this case, it would be in favor of the PPACA.

By granting a hearing in front of the entire DC COA, the court wiped out the three panel judge earlier decision “finding that such subsidies under the Affordable Care Act can only be provided to those who seek insurance on an exchange directly operated by a state government — a potentially crippling blow to the new law.” Only 16 of the 34 initial exchanges were established by states and the rest by the federal govenment. If this decision was allowed to stand and taking into consideration another district’s (4th District COA) decision favoring the PPACA, SCOTUS could take the case as district courts are in conflict. As it is, SCOTUS could still take the case amongst the 85 (sigh) it hears yearly.

December 17, 2014 is the date of hearing and little allowance has been made for continuance as warned.

DC COA to Consider PPACA Subsidies -SCOTUS Blog
Crooks and Liars – DC COA withdraws Defunding of Obamacare Decision

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The Primary & Huge Error of Macroeconomics… Potential Output

What is the primary error in macroeconomics? Potential output… and this error is huge. The measure of potential output is the foundation for many calculations.

  • Natural real interest rate
  • Natural level of unemployment
  • Monetary policy
  • Slack

If you get these wrong, there will be problems. Paul Krugman wrote an article for the IMF, Increasing Demand. He writes…

“First, we don’t really know how far below capacity we are operating… Nobody knows—”

How wrong has macroeconomics been? Well, I am going to compare the CBO projection of potential real GDP with my own calculation of potential from my Effective Demand research.

potential real gdp

As real GDP declined back in 2008, the CBO was not adjusting their projection of potential (pink line). Whereas my calculation (dark red line) moved horizontal for 3 years. My calculation showed that potential real GDP dropped to a lower trend line… a lower “New Normal”.

The red arrowed lines show the discrepancy between my view of potential and the view of all major economists since the crisis. The discrepancy is huge and started early. The macroeconomic discourse has been based on this major error since the beginning… and the CBO downward revisions of potential have not cleared the error.

Assume for a second that my calculation of potential is correct. Then you realize that

  • monetary policy has been misguided.
  • imbalances have been building from erroneous policy for 5 years.
  • Larry Summers’ projection of a negative natural real interest rate is misguided.
  • secular stagnation is just dropping to a new trend line.

I will make two more comparisons of the CBO potential real GDP and the effective demand potential.

Volcker Recession

potential real gdp volcker

During the Volcker recession, real GDP dropped quite a bit. However, the potential real GDP from the effective demand research did not drop to a new lower normal. It followed parallel to the CBO projection… and then moved with real GDP after the recession. The economy had a normal recovery from the recession.

2001 Recession

potential real gdp 2001

In 2000, real GDP (yellow) started to flatten and fall. While the CBO was raising their projection of potential (pink), my effective demand potential (dark red) was beginning to flatten as well. Eventually all lines come back together in 2004.

But the important point is that potential real GDP gives a measure of slack in the economy (unused utilization of labor and capital). This measure of slack is critical for monetary policy. In 2000, the effective demand potential was showing that slack was increasing into a recessionary gap (real GDP less than potential). However, the CBO was still showing a high inflationary gap (real GDP more than potential). Greenspan saw the inflationary gap, saw inflation rising in 2000, expected more inflation and raised the Fed rate. The recessionary gap started to form months later. The effective demand potential said that he should not have raised the Fed rate like he did.

Carl Walsh wrote in 2001 for the Federal Reserve Bank of San Francisco in an article titled, The Science (and Art) of Monetary Policy...

“As the economy grew rapidly during the second half of the decade (1990’s), economists were uncertain whether real output was rising above potential, in which case interest rate hikes would be called for, or whether both actual and potential output were growing more rapidly, leaving the output gap stable.”

The ED potential GDP showed the latter; potential was rising leaving the output gap stable.


In my view, Volcker was not misled by the CBO’s projection of potential. Yet Greenspan in 2000 was misled… Now, the Fed and major economists have been hugely misled for 5 years by a CBO projection of potential that is much too high… Years from now, macroeconomics will look back and recognize this great error.

Note: The equation for Effective Demand potential real GDP…

ED Potential real GDP = real GDP – $3.4 trillion * (capacity utilization/(index of non-farm business labor share * 0.762) – 1)

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A Definition of Money Is Not Sufficient, But it Is Necessary to Understand Economies

Paul Krugman takes aim today at me (though he doesn’t know me from shinola), and others of my ilk who are at least somewhat obsessed with coming to a coherent definition of “money.”

…people who spend too much time thinking about money in general — specifically, on trying to decode money’s true meaning and find the real, true measure of the money supply; they end up starting to believe that everything in economics hinges on getting that measure right, when in fact almost nothing does.

He’s certainly — obviously — right that defining “money” coherently would not be sufficient to give economists an understanding of how economies work. But I’m here to suggest that it is a necessary condition — that absent such a definition, economists are inevitably fated to wrestle endlessly with incoherent understandings of how economies work.

Economists are like physicists trying to ply their trade without a coherent, agreed-upon definition of “energy.” (That definition is not conceptually simple, but it is coherent and agreed-upon.) Absent that definition, physicists’ discussions would devolve into exactly the kind of unending, unresolvable mare’s nests that are the ubiquitous norm in economics. Cue Truman’s “one-handed economist.”

Without a coherent definition of “money,” it’s impossible to have a coherent discussion — or arguably, even a coherent understanding — of how economies (inevitably, monetary economies) work.

I’ve written repeatedly (you could start here or here) about what I consider to be economists’ central, crippling confusion: even some of the most careful money-thinkers out there (e.g. Isabella Kaminska, J. P. Koenig) frequently confute “money” with “currency-like things.” It’s understandable — we’ve always considered Roman coins to be “money” — but it’s a vernacular understanding that considered carefully, is conceptually incoherent.

I’ll end by again bruiting my preferred definitions of “money,” “financial assets,” and “currency,” and pointing to my many previous posts explaining those definitions’ undeniable virtue (and difficulties):

Money is the exchange value embodied in financial assets.

Financial assets are legal constructs defining claims. The exchange value of those claims is “money.”

Physical currency consists of physical tokens representing balance-sheet credits (claims), so it is actually an extra step removed from being “money.”

So financial assets (even dollar bills), which embody money, cannot “be” money.

These definitions cannot be “true.” I only suggest that they are the most useful, coherent definitions for thinking about economies that I’ve been able to come up with.

To return to Krugman: by this definition, the most useful measure of the money stock (in understanding and exploring how economies work) is not any measure of currency-like things (M1, M2, MB, even divisia measures), but household net worth.

In the big picture, money = household wealth: households’/people’s net stock of claims on all our real stuff (tangible and intangible). Or to be conceptually precise: the money stock = the exchange value of those claims.

Cross-posted at Asymptosis.

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Chickens vs. A Turkey

Okay, so most of you who don’t live in Iowa (and most of you don’t live in Iowa, since it’s not a populous state) probably are unaware that the outcome of the election to replace retiring progressive Iowa senator Tom Harkin—which in turn may determine party control of the Senate—may turn on a dispute between neighbors in a subdivision of homes near a lake in Brooklyn, Iowa.

I don’t live in Iowa either, but I’ve known about this for nearly a month.

The dispute is between Democratic nominee Bruce Braley and his wife and their neighbor, a woman named Pauline Hampton, who raises chickens on her property, which abuts the Braleys’ backyard.  Hampton’s chickens regularly escape from their coop and dirty the Braleys’ and other neighbors’ yards.  Braley’s wife had repeatedly asked Hampton to keep her chickens cooped rather than simply allowing them to roam freely and then come home to roost, but to no avail.

After a verbal spat between Hampton and Braley’s wife, Braley contacted the president of the homeowners’ association and asked that he intervene with Hampton.  He said he did not want to litigate the matter in court and hoped instead that the homeowners’ associate president could prevail upon Hampton to keep her chickens cooped.

Instead, though, the homeowners’ association president, a Republican activist, acted neighborly and reported the private conversation to Republican senate nominee Joni Ernst, a noted constitutional scholar and historian.  Mistaking himself for a court clerk, or believing that Braley had mistaken him for one, the homeowners’ association president apparently told Ernst, and in turn the news media, that Braley had contacted him in order to file a lawsuit.  Something like that, anyway; as I said, I’m not an Iowan, so I’m not familiar with the Iowa way and Iowa neighborliness and such, so I may have missed something here.

Anyway, the political news media of course reported Braley’s contact with the homeowners’ association president as NOT THE IOWA WAY, since Iowans do not resolve conflicts by asking homeowners’ association presidents to mediate conflicts.  Not homeowners’ association presidents who also are Republican activists, anyway.

Well, today, Greg Sargent posted a blog post at the Washington Post titled “Will Iowa Senate race be about issues, or about chickens?”  He reports on minimum-wage numbers-crunching included in a new report by the Center for American Progress Action Fund and says the report’s conclusions about the impact a wage hike would have in Iowa “contrast starkly with Ernst’s pronouncements about it.” Those pronouncements include statements that the minimum wage should be abolished or at least remain forever at its current federal hourly rate of $7.25, and that most minimum wage earners are in their teens or early 20s and in any event are not their family’s main breadwinner.

As the election nears, Ernst likely will continue to lay eggs.  But the ones already hatched expose her for the turkey that she is.

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Vacuum around Effective Demand in Secular Stagnation ebook

I have been reading the ebook on Secular Stagnation. It is interesting that two sections in the book have the titles…

  • Three Issues: Potential Growth, Effective Demand and Sclerosis
  • Further on Effective Demand

Great! We see the term Effective Demand being used. Yet, Effective demand is never defined in the book. Moreover, the term is only used ONCE in the whole book.

“These policies are usually clustered under the heading of “structural reform” or supply-side policies, but they also help if the “lack of effective demand” version of secular stagnation turns out to be correct.” (page 17)

The term is used in quotes as if they are not sure what effective demand is. There is a vacuum around the prominent term Effective Demand in that high-profile important book.

Effective demand is not just insufficient aggregate demand. It is a limit upon production that will keep the economy from returning to full employment. If it turns out that the economy is unable to return to full employment due to demand, the culprit would be “Effective” demand.

I have a way to determine that effective demand limit, but the economists in the recommended ebook on secular stagnation do not yet. They are even unable to use the term in a sentence. So why do they even use the term in section titles? Well, the understanding of effective demand is working its way into the field of economics due to the strange things being seen.

It is good to see the term effective demand being used, but it will be even better when economists learn what it is and how to calculate it.

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Fisher Effect & Euro Crisis

flower castle

The ECB raised its benchmark rate in 2011 from 1.0% to 1.5%. Since then the rate has moved down to 0.15%. After their benchmark rate was raised in 2011, the Euro area went into a recession. Did the ECB cause the recession by raising their benchmark nominal rate? Some say yes. I say the story is more complicated than that.

The Euro area’s core inflation rose during the tick up in the benchmark rate in 2011. Inflation began to rise in the face of wage cutting across the continent. Raising prices and cutting labor costs is not a good mix for society though. So the ECB acted to restrain inflation.

Core inflation has been falling ever since 2012 when it became clear that the ECB would commit to low rates for a long time. This is the Fisher Effect where inflation will adjust over time to the natural equilibrium between long-term nominal rates and the natural real rate.

A little more context for the Euro recession… Great Britain started to contract in 2010 before the Euro benchmark rate was raised. Loans to private sector were actually rising during the tick up in the benchmark rate. Germany did not go into recession. The recession centered around the periphery countries of Spain, Greece, Portugal and Ireland. So what happened?

The Euro area has become a net exporter since 2011, which implies that there was a decline in domestic consumption which raised the area’s “national” savings. The rise in “national” savings would need to be offset by a rise in their current account. The Euro area became a net exporter after the recession.

Do you remember the wage disinflation policy from Germany with their Agenda 2010? This policy spread through Europe and there was a contraction in demand through part of 2010 and 2011, not only at the household level but also at the public level. The effect was to raise national savings by lowering labor share, and thus increase their exports from maintaining a balance of payments internationally. The suppression of wages across Europe laid the foundation for their recession.
Wage shares fell most in Spain, Greece, Portugal and Ireland. The periphery countries had to lower their wage costs in response to Germany (and France) because they could not devalue their currency. The recession was centered most in these periphery countries. Credit markets were tight. Debt levels were still high.

There is much more to the story than just… The ECB caused a recession by raising rates. There was an adjustment process to transform Europe into a “net exporter” area. The process created an economic contraction first, then “net exporter” status second. The process was most damaging to the periphery countries. Now, even though Europe is a net exporter which many desired, domestic demand is so weak that their economy is struggling.

Since 2011, the nominal benchmark rate of Europe has dropped to near zero with projections to stay there for a long time. The Fisher Effect says that inflation will decline with lower nominal rates in order to seek the natural real interest rate equilibrium.

Bottom line: When you damage an economy by lowering labor share to increase export potential, you will need an ever lower nominal rate because potential output is reduced to a level where the economy cannot return to full employment. But inflation will go lower as a response to seek the integrity of the natural real rate. The result is a downward spiral… which is now visible in Europe.

Note: A large part of the reason why China did not have higher domestic inflation was due to the fact that their labor share fell a lot over the past 15 years.

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Dana Milbank Joins Parade Of WaPo Hysterics Over Social Security And Medicare

Barkley Rosser at Econospeak writes an op-ed on the Washington Post’s reporting:

Dana Milbank Joins Parade Of WaPo Hysterics Over Social Security And Medicare

Dean Baker has posted on this more completely and effectively than I shall do here (and his url is so long on this one, I shall not link directly, sorry), but I simply want to throw in my two cents completely supporting him on this.  As several of us have been doing for some time, we have been criticizing a bunch of Very Serious People (VSPs) at the Washington Post (WaPo) for their repeated rantings and ravings to the effect that the US faces an awful future due to its future liabilities with regard to both Social Security and Medicare, with somehow these people usually focusing on cutting future Social Security benefits now, because if we don’t, eeeeek, we might have to in the future (and they somehow also think that this is easier to achieve politically than other budget adjustments.).  Those in this parade have long been led by editorial page editor, Fred Hiatt, who often does columns under his own name as well as unnamed ones officially for the Post, on this matter.  His most regular follower on this has been the long execrable Robert J. Samuelson, although Ruth Marcus is also part of this group.  It is sort of funny that most of these people are nominal liberals, sort of, but it means that WaPo’s house conservatives such as George Will can ignore this issue to prattle on about other stuff, given that these people spout conservative lines on this matter.

So now we have yet another of these sort of nominal liberals joining this pathetic parade, Dana Milbank, and he makes an even bigger spectacle of himself than most of these others do, waxing seriously hysterical about the matter.

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Lump of Labor Day Special: Advanced (Elementary) Concepts in Mathematics

Sandwichman at Econospeak writes more on the issue of ‘labor’:

Lump of Labor Day Special: Advanced (Elementary) Concepts in Mathematics

“…if there be but a certain proportion of work to be done; and that the same be already done by the not-Beggars; then to employ the Beggars about it, will but transfer the want from one hand to another…” – John Graunt, 1662.

In a previous post, Graunt Work, I discussed the theological foundations of John Graunt’s Natural and Political Observations made upon the Bills of Mortality and hinted at the unacknowledged survival of assumptions of divine providence in expectations of a harmonious social order. This post is concerned with the distinction between the “certain proportion of work” assumed by Graunt (or possibly inserted by Petty) in his discussion of employing beggars and the “fixed amount of work” assumption, alleged by economists to be a widespread fallacy.

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What John DiIulio Said

I think this is too good to excerpt just read
“Want better, smaller government? Hire another million federal bureaucrats.”

by John DiIulio. He argues that the obsession with keeping the number of Federal civilian employees low has reduced efficiency and created powerful concentrated interests represented by powerful lobbies. The fact that he was “the first director of the White House Office of Faith-Based and Community Initiatives”under W and assigned the task of replacing “bureaucrats” with non-profits makes his current argument more striking.

I have only one objection to the article. DiIulio argues that the too small workforce lead to poor performance by the Veterans’ Adminstration “And the recent scandal at Veterans Affairs hospitals, whose “contract officer’s representatives” are too few to properly monitor what the small armies of contractors at VA medical centers do.”

There are two problems with this example. Neither DiIulio nor anyone else has presented evidence that the VA provides other than the best health care in the USA. The scandal is what the VA did compared to VA standards not compared to other US health care providers.

Also if the example were valid (which it isn’t) it would tend to undermine DiIulio’s argument. The VA relies much more on public sector employees to perform services directly than the rest of the US system does. If it provided worse care than Medicare, Medicaid, private insurance, out of pocket or charity, the case for public provision of services would be weakened.

The two errors cancel. the case of the VA provides strong support for DiIulio’s proposal (as does the case of Medicare Advantage and Fannie & Freddie state owned vs privatized and … way too many examples to list).

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