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

Trash the AS-AD model, but Leave my AS-ED Model Alone

Olivier Blanchard is criticizing the Aggregate Supply-Aggregate Demand model…

“Turning to the supply side, the contraption known as the aggregate demand–aggregate supply model should be eliminated.” (link)

Let me show you something good… I am the only one in the world using this model of Effective Demand with Aggregate Supply…

ased years2

What you are looking at is all of the effective demand limit curves from 4th quarter 2008 to 4th quarter 2014. That is 6 years of quarterly data. The crisis started at the end of 2008.

Notice how all of the curves point to a zone at a core inflation target zone of 2%. All of the curves fall into a zone from $15.9 to $16.2 trillion (real 2009 $$) at that core inflation target zone.

When real GDP reached $16.1 trillion in the last half of 2014, hitting the heart of that zone marked in the graph, corporate profits peaked and other factors peaked. The effective demand limit curves began to balloon upward. The business cycle peaked. This AS-ED model had seen it coming for 6 years. That is what the AS-AD model could do, if it incorporated effective demand.

Here is what happened when real GDP hit the zone… You can see the effective demand limit curves starting to move out toward a new zone for the next business cycle. That is how it works.

ased years4

Think about it… The top of the business cycle was seen developing as far as 6 years in advance by this model!

Olivier Blanchard can eliminate the AS-AD model, but nobody touches my AS-ED model… This model is golden.

Update: The 2nd graph above does not mean that inflation is going up to 8%. The red dots show where the AS and ED curves cross. Those crossing points fall toward the natural limit zone as the AS curves move right in the 1% to 2% inflation horizontal. As real GDP goes by the natural limit, the crossing points move start to move upward like bouncing on the limit zone. Real GDP still moves below near 2% core inflation.

Look at the black horizontal arrow in the 2nd graph that says… “track of real GDP”… that is real GDP moving along near 2%… but the ED limit curve crosses the projected future path of real GDP shown by the black arrow. That crossing point shows us where real GDP will encounter its natural limit.

Update: Effective Demand limit curves use the same equation as in this model for the Effective Consumption Demand curve…

limit model 4d

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Real Rate Integration with Model of Effective Demand

With the temperature reaching 120 degrees here today in Phoenix (almost a record), allow me to have a little fun with my theoretical model of Effective Demand.

There are two equations in my effective demand research that will be integrated in this post.

First the Effective Demand equation…

Effective demand limit upon real GDP = rGDP*e*T/L* (1 – (1 – 1/e)*T/L)

rGDP = real GDP
T = capacity utilization * (1 – unemployment rate)
L = an effective demand limit function based on labor share.
e = around 3   (more on this below)

limit model 4d

The blue dot in this model represents an unstable equilibrium. The economy would seem to want to move away from this blue dot, either toward collapse or balanced growth.

Now the other equation to be integrated is the short-term real interest rate for monetary policy. This equation comes from my effective demand research.

Short-term real rate = z(T2 + L2) – ( 1 – z)*(T + L)

z = (2*L + Natural real rate)/(2L2 + 2L)

Both equations are also based on T and L, but this short-term real rate one incorporates the natural real rate.

real rate model

Does it make sense that the real rate would start rising below a T of 40%? Shouldn’t the real rate just keep falling to support the economy at lower and lower rates of resource utilization? We need to integrate the above two models to answer that question.

Notice that the minimum of the short-term real rate at 40% matches the unstable equilibrium in the model of Effective Demand.

Let me put them both on the same graph so that you can see. I put production on the left axis and the interest rate on the right axis.

integrate real ED1

Now we can answer the question… Why would the short-term real rate rise going below 40%?… The idea would be to lead the economy toward the unstable equilibrium by lowering rates going from 0% to 40%.  The central bank says, “The more you use labor and capital, we will lower rates to counteract the force pushing the economy away from the unstable equilibrium toward collapse at 0%. ”

Once on the right side of the unstable equilibrium, the short-term real rate can start to rise slowly toward the natural effective demand limit. (80% in the graph above.) At the natural limit, the short-term real rate would be 0% representing a normalized policy rate from a central bank.

The graph above is based on a natural real rate of economic growth of 0%. But what if the economy was growing at 5% or shrinking at -5%? What would happen to the graph? Let’s look at an economy growing at 5%.

integrate real ED2

The blue dots do not match up now. The short-term real rate has a new minimum at 37.3%. Now what do we do?

We look at the equation for the Effective Demand limit and see the coefficient of e. We can use that coefficient to calibrate the ED limit equation for the natural real rate. Even though the most precise equation would be a very flat quadratic, a sufficient equation is linear…

e = 3.3*natural real rate + 3

So for a 5% natural real rate, the coefficient e would adjust to… 3.3*0.05+3 = 3.165.

integrate real ED3

So with just a little change in the e coefficient, the effective demand equation adjusts to the short-term real rate equation. Red dots still match up too.

Now the effective demand equation also incorporates the natural real rate. That is an advancement in the theory.

Happy harmony!

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Soul-searching at Fed is beginning

The soul-searching at the Fed is beginning.

I have written many times for over a year that the Fed will have a period when they start soul-searching. They will realize that the business cycle got away from them and they will not be able to normalize rates. They just got too far behind the curve.

Danielle DiMartino on Boom/Bust said, “I think it was probably one of the most interesting FOMC meetings… I think the fact that Esther George did not descent is telling you that there is an acknowledgement among members of the committee that the United States is probably headed toward a recession.”

DiMartino goes on to say that the Fed should never go to zero bound again and maintain a 2% floor for example, so that the banking system can function in a natural way. 0% does not allow the market to discover prices efficiently.

I do not agree with her on that by the way. The Fed rate should be able to go to 0% but then lift off according to the biz cycle of effective demand. In my view, the Fed should have started lifting rates at some point in 2012. There was still some spare capacity available for the economy to adjust to the disciplining of productivity by raising rates.

fed ED2

Update: A similar view is presented by Signe Krogstrup. (link)

fed alt2

There is hardly any spare capacity left. Profit rates and top line revenue peaked at the end of 2014. The Fed rate is too far behind the curve. The Fed will not be able to raise rates going forward without triggering a contraction.

The Fed is frustrated. They want to normalize rates, but won’t be able to.

The soul-searching has begun.

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Checking on 2016 Predictions

On January 6th, I made some predictions for 2016. (link to post). Let’s look at some of them.

#1. I saw a higher probability than Tim Duy for a recession. He did not predict one. We do not have a recession yet.  I wrote, “It is possible that the economy could stabilize by the end of the year if labor share continues to rise carefully and not too fast to spook business. The US consumer could come to the rescue and keep the business cycle alive.” Labor share is rising fast and spending is increasing. I still hold to about a 70% chance of a recession by the end of 2016.

#3. I saw 2016 as the year that unemployment stops falling and begins to level out. Is the 4.7% unemployment rate the bottom? That remains to be seen by end of 2016. My view is that we are seeing unemployment hitting its bottom level and will eventually go up from here over the next year.

#5. Inflation has not increased much since January of this year. I said it would keep increasing but with a caveat, “But even so, cascading economic weakness globally would weigh down inflation.” Global economic weakness is apparent in parts.

#6. I predicted that oil would stay in the range of $30 to $47 a barrel for 2016. It is gone up over $50, but has recently moved below $48.  I see that $50 was the peak and that oil will move down from here as internal weaknesses in the US and global economies develop.

#7. I held to my view that the Dow would tend to move around the 17,500 level. It went to 18,000 but is now down to below 17,700. I see the stock market getting weaker as the year progresses.

#9. I predicted that the Fed would want to raise rates and probably would but with the caveat, ” The Fed can only raise rates very slowly when up against the effective demand limit of peaked profit rates. Still, I see that the Fed will have to think very hard about maintaining a pace to raise rates. The economy is more vulnerable than the Fed appears to think.” I think after holding rates steady today, the Fed realizes how vulnerable the economy is. Market participants get the message and are a bit more worried about the economy than they were last week.

10#. If productivity starts to rise, it is a sign for me that a recession is forming. So far in 2016, productivity is not rising so much.

 

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Reality settling in

Looks like the Fed is finally understanding that they are behind the curve and not able to catch up to the curve without triggering an economic contraction. Now we will see how long the business cycle can hold on.

I still see an economic contraction starting by 2nd quarter 2017.  Still a 70% chance by end of 2016 as I predicted back at the start of January. The only difference now is that reality is settling in more at the Fed and market participants.

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A New Model of the Economy Please

Brad DeLong wrote recently concerning the Uncertainty at the Fed

“The heart of the trouble consists in the fact that neither financial-market participants nor, it seems, the Fed itself know the true state of the economy or how best to model it – especially in the wake of the 2008 financial crisis” (link)

It is a fact he says. The Fed and others do not know how best to model the state of the economy.

I stand alone with a new model for an Effective Demand limit as Keynes envisioned it.

The basic concept behind the model is that the percentage that labor receives of national income determines a limit upon the utilization of labor and capital in production. The key idea is that capital income based upon utilizing capital resources is optimized at the effective demand limit. Thus capital does not want to go beyond the limit because it begins to consume its power position in the aggregate. Capital seeks to consume labor income while maximizing its relative strength in the economic flow of money.

So why is my model good? While Brad DeLong points out the confusion from the Fed, my model is not confused.

  • It knows why capacity utilization is dropping and why unemployment stays low.
  • It knows why the output gap has continuously been revised downward, because the output gap was closed years ago in this business cycle.

output gap update

  • It knows why the Fed seems to want to normalize rates. The economy is at the end of the business cycle. Rates are supposed to be close to normalized by now.

So the confusion over where the state of the economy is has led to the uncertainty that Brad DeLong writes about… on both sides, the central banks and the market participants. We see a situation where the market participants see a different economic potential than economists. They have seen limitations in this business cycle. Yet the Fed is still waiting for inflation and demand to pick up, while top line revenue of firms has already topped out in the aggregate.

The Fed still sees that this business cycle will stay alive for another two years.  The disconnect has been severe for many years causing sluggishness in the economy.

The Fed does not want inflation above target because higher inflation causes distortions and slows growth. However, they have entered another situation where there models are misreading the state of the economy and leading to sluggishness anyway.

What is the equation of the effective demand limit?

Effective demand limit upon real GDP = rGDP*e*T/L* (1 – (1 – 1/e)*T/L)

T = capacity utilization * (1 – unemployment rate)
L = an effective demand limit function (Labor share index * 0.76)
e = 3 … coefficient to set maximum of effective demand at the stable equilibrium with production.

Effective labor share (L) determines the limit upon the % utilization of labor and capital in production. The following graph portrays Keynes’ vision of Effective Demand quite well. Let’s bear in mind that Keynes never gave an equation for effective demand. He only described how it seemed to work.

This equation works. The economy has followed this model for as long as we have data for capacity utilization… since 1967 to now.

limit model 4d

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Attractor State of Productive Capacity is Shifting

What is an attractor state?

It is a state around which a dynamic system organizes itself.

Self-organization is the spontaneous often seemingly purposeful formation of spatial, temporal, spatiotemporal structures or functions in systems composed of few or many components. In physics, chemistry and biology self-organization occurs in open systems driven away from thermal equilibrium. The process of self-organization can be found in many other fields also, such as economy, sociology, medicine, technology.

“Stable internal representations of the external world indicate the presence of attractors. Here, an attractor means one of the states of the system where the system settles after starting from a given initial condition. Self-organization needs these attractors to have a sufficient instability to be able to alter in order to adapt to the environment.”  (Self-organization at scholarpedia.org)

The plot below will show how the economy settles into an attractor state for Productive Capacity. Then it breaks away from the attractor state to adapt to a new environment of economic growth for the next business cycle. The economy shows both stability and instability in the graph. That is the key to an attractor state of self-organization, adaptation and growth.

Here is the graph which plots Real GDP against the TFUR… (capacity utilization * (1 – unemployment rate). (TFUR is what I call Total Factor Utilization Rate.)

update attractor productive cap

Productive capacity is found where the attractor lines cross a TFUR of 100%.

The pattern is normally for the plot to follow a line originating at the crossing of the x and y axes during the growth phase of a business cycle. This line represents an attractor state for the growth in a business cycle. Then the plot rises above the line and falls to the left into recession setting up the next business cycle at a higher attractor level of Productive Capacity and Real GDP.

The 1990s were an exception because the plot kept rising without the TFUR falling into a recession.

This updated graph shows that the economy has lifted off from the current attractor state and is heading toward the future projected attractor state.

How will we get there?

There are two possibilities…

  1. A recession
  2. The TFUR stays stable while Real GDP keeps rising. But the key is to have increasing productivity. This happened in the 1990s.

We do not see increasing productivity growth, so the most likely path will be through a recession.

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Circular Flow of Labor & Capital

In the study of economics, one learns the circular flow of the economy between firms and households. This post however presents another circular flow model based on capital and labor. (It is a closed economy with no government for simplification.) There are 4 pools within this circular flow related to the income and utilization of labor and capital.

cap lab circ flow

In the center of the model is the percentage of national income from production that goes to owners of capital. We do have a capitalistic economy. The control of capital is at the center of the economy. Capital income is central to determining the pools around it… the percentage of national income going to labor and the percentage utilizations of labor and capital.

This circular model is different because we do not see money going back and forth between entities. Instead we see dynamics of utilization and distribution between one pool and another.

Share of Income between Capital & Labor

At the top of the circular flow is the relationship between how much of national income goes to capital and labor. For the most part, this is determined by owners of capital because they control the equipment, investment funds and other capital used for production. Then they hire labor to work with the capital.

There is a historical power struggle between capital and labor for sharing the income from production. Strikes, walk-outs and killings define the history. When labor loses bargaining power, labor share of income tends to fall. What effect then do changes in labor share affect the utilization of labor and capital?

Relationship between Labor Share & % Utilization of Labor (Green line in model)

In production, labor needs to be hired. The amount of available labor supplied depends on labor’s share of income from production. Here are some graphs to show this relationship. (update: The following graph presents the Unemployment rate as the percentage employed, instead of unemployed.)

update ls unrate

As the labor index rose to over 112 in the 1950’s and 1960’s, unemployment increased. The utilization rate of labor looked to be limited by the demand of capital owners.  Since then, labor share has fallen. Now it looks as though labor is limiting its own supply. The implication is that labor is less willing to supply its labor when its share of income is low.

We see this relationship also in the Labor Force participation rate.

update ls LF participation

When labor share was higher, the percentage of labor participating in production was higher. The steep decline in labor share since 2003 was accompanied by less labor participating in production. Granted there are other demographic influences. Still there looks to be some effect of lower labor share on the LF participation rate.

Relationship between Labor Share & % Utilization of Capital (Red line in model)

This relationship triggered by personal economic research in Effective Demand back in 2012.

As labor share of income falls, so does the upper limit of the utilization of capital (lower red line in the following graph.)

update ls cap util

Since the 1960’s, the maximum of capacity utilization in business cycles has fallen to lower levels with lower labor share. The effect of lower labor share upon capacity utilization is how I define Keynes’ concept of Effective Demand.

Relationship between Labor Share & both the % Utilization of Capital and Labor

This relationship involves the 3 circles around capital share in the circular flow model above.

Upon seeing how labor share limits the utilization of capital, I noticed an effect from the utilization rate of labor. So I developed a simple equation…

Labor share index * 0.76  >=  capacity utilization * (1 – unemployment rate)

The equation basically says that a labor share conversion (* 0.76) would set an upper limit to the value of multiplying together capacity utilization and (1 – the unemployment rate).  (0.76 was the slope of the midline tendency above in the plot between labor share and capacity utilization that zeros in on the limit.) So, in effect, the unemployment rate established the limits of capacity utilization in relation to labor share.

We see this in the following graph. (link to Fred data)

fred ut

The plot tends to stay above the zero line showing that the equation holds from business cycle to business cycle, including the current strange one. The converted labor share rate is seen to set a limit upon the multiplied utilization rates of labor and capital.

The Relationship between the % Utilization of Labor and Capital (Violet line in model)

As the business cycle recovers after a contraction, both the utilization rates of labor and capital increase. But there comes a point where the utilization of capital will stop increasing or fall. This point reflects an optimum use of capital as I show below. The utilization of labor may keep increasing or fall at that point.

How can this dynamic be put into an equation?

The following 3-dimensional equation gives a value for a z-vertical. As the z-vertical rises, capital and labor is used more optimally and the business cycle keeps progressing. The goal is to keep increasing the z-vertical as long as possible through a business cycle. A rising z-vertical shows optimum utilization of labor and capital.

z-vertical = m + k – am2k2
m = (1 – unemployment rate)
k = capacity utilization rate
a = 1.46 – 0.76 * labor share index

 The maximum of this equation is…

Max of z-vertical = √1/2ak … (square root of 1/2ak)

Here is a graph.

update path cobra

In the last year, capacity utilization has been falling while the utilization of labor has been increasing (unemployment falling). The equation predicted this. Yet has the z-vertical continued to rise? (link to following FRED graph)

update z-vertical

Yes, the z-vertical has continued to rise in this business cycle. However, the z-vertical is at lower levels in relation to the past which reflects the poor economic environment currently. A low z-vertical ultimately reflects under-utilization of both capital and labor which is a result of the lower than optimum labor share.

Now, I look at the derivatives of the above equation in terms of both capital and labor. A higher derivative means lower than optimum utilization.

First, the derivative in terms of capital. (FRED link)

in terms of capital z-vert

Capital utilization is always brought to its optimum during a business cycle. That is the priority of capital income at the center of the circular model. Capital has the advantage over labor.

Now, the derivative in terms of labor. (FRED link)

in terms of labor z-vert2

Unlike capital, labor never reaches its optimum utilization since it never reaches zero in the graph. Capital comes first in capitalism. And since the 1990’s, the utilization of labor has been getting worse as seen by the plot steadily trending upward. The increasingly unmet potential of labor utilization coupled with lower labor share is a problem.

Capital has not lost its advantages while labor has.

The utilization of labor has also been decaying since the end of 2014. So when economists say that the labor market is looking hopeful, I have seen the labor market getting progressively worse and heading toward an economic contraction.

Conclusion:

The rise in power of the monopolies that Joseph Stiglitz writes about is giving more power to capital income. The above dynamics between labor and capital show the adverse impact upon labor. The result has been lower labor force participation, higher unemployment, lower capacity utilization, a weakening utilization of labor and an ever more sluggish economy.

Something needs to be done to give power back to labor.

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Internet shedding light on hidden history of Mormonism

The Mormon church reaches out over the whole world to get converts. Their missionaries present pamphlets about their history and doctrines. The pamphlets paint a picture of wholesomeness and purity. Yet the pamphlets are propaganda that distorts historical truth.

It is important to know the truth behind Mormonism because members of the church have become economically and politically powerful, for example, Glenn Beck and Mitt Romney. The internet now allows people to bring together all the historical documents to piece together the true history of Mormonism.

What is the basic image portrayed by the pamphlets?

jstranslatesbom4

A young pure-hearted boy named Joseph Smith was disappointed by the churches of his day and asked God to know the real truth. Then one night an angel, named Moroni, visited him floating in the air surrounded by a bright light and gave him instructions to look for golden plates hidden in the forest. The angel visited him 3 times. He was supposed to translate the plates and restore the true church of God to the earth. He found the plates in the forest and eventually translated them. At one point, both God and Jesus appeared to him giving him blessings. The pamphlets show images of a noble-hearted Joseph Smith sitting at a table with the golden plates next to him while he translates them. The angel Moroni who had hidden the plates centuries before was his guide to translate the plates. The translation became the book of Mormon.

What do the historical records now show? (I am leaving out many details to keep this post short.)

Joseph Smith in his youth would put a stone into a hat. He had found this stone in a well. Then he would look at the stone with the hat closed around his face. Then he would tell people where hidden treasures were in the forest. He would receive money for this information. He would take people into the forest and point to a spot to dig. Upon not finding the treasure, he would say that the treasure had moved through the earth because someone had disobeyed the guidelines of the spirit. They would have to dig in another spot nearby. He was once charged with disorderly conduct because of these deceits.

Joseph Smith came from a family with a tradition of magical folklore. According to this folklore, an angel had to visit 3 times to be true. If not, the angel was not telling the truth. There were all sorts of angels purported to visit the people in that tradition. The angel Moroni came 3 times to satisfy that folklore tradition and the blessings of his folklore father who encouraged young Joseph Smith to bring him the plates. But Joseph said that the angel would not give him the plates.

500px-Anthony_Sweat_Translating_with_Martin

It turns out that the Joseph Smith did not translate the plates as shown in the pamphlets. He actually would look into a hat at the same stone he had used to find false treasures. Then he would speak the story while someone sitting near him would write down what he said. A few different people ended up writing his dictations. He would say the plates were still in the forest or in a nearby box while he saw words on the stone. He said that he was receiving the translation with the help of the angel Moroni.

Most Mormon temples put the angel Moroni on top. Was this angel real or a fictional character in a novel? Nobody but Joseph Smith ever saw the angel Moroni. Did he see it in his imagination, or was the angel real?

4214316

In his youth, Joseph Smith would entertain his family and friends with grand stories of the past and a history of the Indians. They would all sit around and listen to him weave stories. They enjoyed his stories according to historical accounts. The book of Mormon also tells stories of the past and the history of the Indians. Joseph Smith had a talent for story-telling. Was he preparing stories that would eventually become the book of Mormon?

At the beginning of the book of Mormon, witnesses signed a document to swear that they had seen the golden plates. When some of these people were pressed later if they had seen the plates with their physical eyes, they said that they had seen the plates with their spiritual eyes instead, like seeing a city on the other side of a mountain.

Let me present another historical event… The book of Abraham written by Joseph Smith.

One of the canonized books of Mormonism is the book of Abraham. The story is that an actual Egyptian scroll made its way to Joseph Smith by a traveling salesman while he was living in Kirkland, Ohio. The scroll was torn a bit and missing some pieces. Followers of Joseph Smith knew he could translate the scroll since nobody in the world was able to translate that forgotten language. And Joseph had translated the plates. So Joseph Smith said he could translate the scroll. He talked with some friends with money and bought the expensive scroll. Then over the next few weeks, he wrote the translation of the scroll. The translation tells a grand story of Abraham and came to be called the book of Abraham.

Years later the Rosetta stone was found and scholars were able to translate ancient Egyptian. As it turns out, Joseph Smith’s translation was complete fiction and had no relation to the common funeral scroll. The actual scroll that he translated was eventually found in a museum. His wife, Emma, who had bitter memories of her husband’s adulterous relationships (more dark secrets of Joseph Smith) gave the scroll to a museum with a letter of its history.

A mormon missionary told me that the book of Abraham was a higher truth of the scroll. Joseph Smith had given us a higher understanding. So could it be that Joseph Smith’s translation was truer than the true translation?

Records of these historical accounts were scattered and unknown until the internet and computers allowed people to assemble them and develop a complete story of the truth (lies) behind Mormonism.

The leaders of the Mormon church are currently trying to hide and spin this history. They have too much invested to allow the church to collapse.

Some more history…

Blacks had been seen by the church as accursed by God since the 1840’s. The Mormon church decided to allow Black’s to be priests in the late 1970’s. That is a good thing, right? Well, at the same time institutions of discrimination were losing tax-exemption under Jimmy Carter, like Bob Jones University. The Mormon church was vulnerable to losing their exemption too.  A revelation from God was imminent.

“In 1978, the First Presidency and the Twelve, led by Spencer W. Kimball, declared they had received a revelation instructing them to reverse the racial restriction policy.” (source)

Money talks in the Mormon church. Their prophet and apostles of Jesus and God built a $5 billion mall. At the grand opening of the mall, the current prophet of God, Thomas Monson, said, “1 2 3… Let’s go shopping!” and cut the ribbon.

“When it came time to cut the mall’s pink ribbon, Monson, flanked by Utah dignitaries, cheered, “One, two, three, let’s go shopping!”

While watching a religious leader celebrate a mall may seem surreal, City Creek reflects the spirit of enterprise that animates modern-day Mormonism. The mall is part of a vast church-owned corporate empire that LDS leadership says will help spread its message, increase economic self-reliance and build God’s kingdom on Earth.” (source)

The church puts their apostles at the same level as the apostles of Jesus. Can we imagine the apostles of Jesus opening a mall and promoting shopping? Maybe they would have if it meant tax exemption.

ldstab_mormonmoney_10212~1

There are many many more hidden deceits in the history of the Mormon church that the internet is making known.

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