A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Sunday, January 8, 2012

Transcript: 488 An economist walks into a bar....

The standup economist is Yoram Baumann, and if you’ve ever heard him do his Mankiw bit, you’ve laughed. But economics is full of jokes told by serious people not realizing they are jokes. It is a profession of straight men and a few women, who have no sense of humor. Not that they’re solemn like funeral directors, they’re just clueless.
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One piece of evidence is the Phillips Curve. This is the relationship between inflation and unemployment. Economists will seriously assure you that there is an inverse relationship. Our intention at demand side is to produce a joke book where, on one page, this assertion is made. A clear relationship between inflation and unemployment. Turn the page and see the Phillips Curve.

There you will see a – what – corkscrew? If you get one where the data hasn’t been cherry picked, it will look like your three-year-old got hold of a pen. That is, there is no useful relationship between unemployment and inflation.

Check out the blog for versions. We even provide the idealized version, which shows a clockwise circle.

But to show you we are real economists, we are going to destroy whatever humor in the joke by explaining it ad nauseum.

Inflation is a symptom, an effect. General price changes can be useful. They can be harmful. For example, if you assume some prices are sticky downward, then inflation is the only way to adjust relative prices, to adjust prices to another. We’re familiar with the bad version of this when we see energy prices soar and the prices of other goods – like labor -- tank. Another example, as Minsky pointed out, when there are financial crises and debt burdens are too high, those burdens in real terms can be reduced by inflation, and they have been. Nominal debt payments remain the same, wages and profits increase, the relative burden of the debt payment goes down. It has been the recipe for recovery since 1980. In fact, Minsky believed it would always be so. He never envisioned authorities letting things get out of hand as they have in the current stagnation.

Consumer price inflation involves things like energy. The great inflation monster came out of the 1970’s with the Iran oil embargo and the rise of OPEC. I don’t see that anywhere in the Phillips Curve. Oh yeah, it’s the top loop, and the other high loops.

A lot of things can go wrong when you think inflation and unemployment are equal evils. You can manage your economy to keep inflation low and generate Great Moderation that is cover for the stagnation of wages and the rise of asset bubbles. That’s what we’ve seen. Great asset bubbles in the 1990s and again in the 2000s, price explosions completely off the inflation screen, because measures of general inflation do not include asset prices. So the devastating bubbles and busts go completely outside the radar, while inflation in consumer prices gets jumped on with both feet.

There are a lot of things missed when you make inapt comparisons, such as this. Treating a cancerous tumor or an elevated temperature as if both are equally dangerous can make treatment completely nonsensical. My, we’re getting off the track. Be that as it may.

Our position at Demand Side is that investment – public and private – is the necessary driver of full employment, following from the fact that the principle constraint on the modern economy is demand, not supply, and investment is an addition to demand. Investment is not seen in the inflation numbers.

I see we’ll never be a comedian, because we are still wanting to explain our joke. Just look at the examples on the blog. All serious, sober, PhD, solemn economists agree this is the clear relationship between unemployment and inflation. It is displayed in the Phillips Curve. There is no relationship. it is relating an orange to a cow.

Wait till we get to our joke on the Natural Rate of Unemployment, the Fed’s great knee-slapper, the Non-Accelerating Inflation Rate of Unemployment – NAIRU.

But that’s all warm-up for today’s Idiot of the Week.

James Bullard


Crikey! Inflation targeting. That’s what we need! It worked so good for Europe.

In case you’re wondering, we included all the business about minutes and such to demonstrate that the Oracle of Delphi is no competition for the Fed in cryptic pronouncements.

And the Fed has no clue. They’re fighting over inflation when inflation is not a problem, and what inflation there is comes from commodity speculation that they themselves are fueling with the various QE’s. Check out yet another chart on the blog, the money supply. This is supposedly what is going to drive inflation. But it has exploded. The money supply. In the Monetarist view of Milton Friedman, inflation is always and everywhere a monetary phenomenon. Quote-unquote. So either they don’t understand money or inflation is not a monetary phenomenon, always and everywhere. The answer is both. Money is not the exogenous provenance of the Fed, but is endogenous. It comes out of the financial system in booms and goes back into it in busts. Or more rightly is created to finance booms and destroyed when the bust occurs.

So the Fed cannot control inflation even if it wanted to, irrespective of whether that would be a good idea. Back in the 1950s and 1960s they controlled inflation by controlling prices of key goods, not by the magic interest rate button which is like the easy button. You hit it and it makes a satisfying sound, but it doesn’t do anything, or at least doesn’t do what you want it to do.

Yet you have a roomful of bankers and bankers stooges sitting around telling themselves how important they are and how what they do will make a huge difference, so they’d better do something. After giving away the store to the banks, maybe they’d better take care of inflation. Forget unemployment, after all we’ve made corporations as profitable as we can, what more can we do?

Out of the great group think comes, inflation targeting. Now even if the Fed could control inflation with its magic interest rate button, that button operates – as everyone agrees – with a lag of twelve to eighteen months on the short end. Heck, the lag is now into the forty-month range. Inflation happens last month. Steering your car by looking out the back window is not a good idea.

Inflation targeting, then, is basically inflation wishing. And the whole exercise is contrived to publish what the Fed wants to an audience which may believe the Fed can do something, so they will alter their expectations and those expectations will produce the experience of inflation.. You think I’m joking. It is funny. But it is not a joke. This is exactly what is going on here. An elaborate play using as many expensive suits as possible to shift expectations, not really realizing that nobody is paying attention.

There is more in this interview, all exhibiting a complete absence of self-awareness even after the cream pie of the Great Financial Crisis was delivered by the Great Moderation., including Bullard’s amusing assertion that because the middle of the 2000’s was a bubble, we should revise down our estimation of growth potential. We’ll leave you with just another taste, of this minister at the monetary policy court.


Idiot of the Week

It looks to us at Demand Side like the number of forecasts for 2012 is dramatically lower than the number at the start of 2011. Of course, at that time you had three, three and a half, four percent growth projected by economists. While projections from Global Insight, Macroeconomic Advisers, Goldman Sachs were deftly cut throughout the year to make it appear they hadn’t missed the broad side of the barn, there does not appear to be the same eagerness to repeat the experience for 2012.

Yogi Berra once observed in his typical sagacious way:

In theory there’s no difference between practice and theory. In practice there is.

So, however much the demand side explanation diverges from the orthodox Neoclassical market fundamentalism, we remain confident in it. Keynes, the New Dealers, the Galbraiths, Minsky, and now Stiglitz, Soros and Steve Keen are among those who practice and preach an economics that works. But it works in explaining what happens and in prescribing policies that promote the optimal well-being of the society. This is the theory. In practice, economics being a political arena, what is practiced is that which benefits the powerful.

So in the current case, whether power flows to money, or as we state it, money flows to power, you have policy in the hands of non-demand siders, those whose economics is a hash of contradictions and bad assumptions that keep getting blown up by the evidence. But which, we are assured, will work if given enough time.

Of course, this is not true, either. The longer we wait, the worse it gets. Hold on! The economy is recovering, albeit slowly, we hear. Sure, we have trillion dollar deficits, the scourge of the responsible, and zero interest rates, the bane of inflation hawks. But it is in spite of these, not because, that the economy is recovering.

Our view at Demand Side is that the economy is bouncing along the bottom, a bottom which is sloped downward and subject to downside risks. As much as it might seem like old news, or embarrassing to mention in polite company, a business cycle in recovery does not have zero interest rates and trillion dollar deficits. It has investment growth and job growth.

The economics which did not see the crisis until it appeared in the rearview mirror, the economics of saving the banks and glorifying corporate profits, the economics of austerity, socialism for the rich and Darwinism for the middle class…. It hasn’t worked, it won’t work, it can’t work. But it is practiced all the way down, because it is the economics of the entrenched interests and their money is the power in the current political arrangement. At ground zero things blow up, then there is a chaotic search for something that works, we suppose.

For example, in the current European debacle – and look at the Europeans, for all their fiscal responsibility, eyeing the US with envy for our miserable flat line growth. In Europe the debt run up, largely in response to the financial crisis, and the debt service that grows ever larger, must be addressed by austerity, cutting services, reducing wages, to free up the means. How absurdly Hooveristic.

Our point is that the means to repay debt must be in the assets purchased by that debt. We define assets broadly, to include the social assets of education and social order and the public goods of infrastructure. If assets do not generate the net increase in value to pay the debt, debt service will be a reduction of net incomes. A reduction of net incomes means reduced means – sometimes called growth – from which debt may be paid and will thus lead to a downward slope – sometimes called a spiral.

This does not mean that a particular government bond will be defaulted on. It is quite possible the payment will be coerced out of even a falling economy. But it does mean that payment on that bond is derived from non-payment on something else and amounts to a shift of the negative to another. And a downward spiral.

And we have the examples in front of us -- Greece, Ireland, the UK, Spain, and more to follow – whose austerity by command of the market and the instruction of the fundamentalists is leading not to the renewed confidence promised, but to recession and ever higher interest rates and deeper employment shortfalls and larger burdens of debt. AKA the “madness of austerity.”

All justified by an archaic economics that didn’t predict anything, didn’t protect anything and now proposes a lost decade – albeit one year at a time and mostly for workers and homeowners – as the route out.

Well, unfortunately, it is the route – because no other policy, no matter its efficacy, will be tried by the current political regime predicated on the power of money. When President Obama came to office with a promise of pragmatism, we were quite elated. Shoot – even if you’re completely in the dark, stumble around with your hands outstretched and you’ll find the way out. And Obama, by his policy papers, did not seem at all completely in the dark. We didn’t realize “pragmatic” is defined by political necessity, not economic welfare.

In the first year of the New Deal under Roosevelt, you had the Public Works Administration and the CCC. In the third, the WPA. Direct employment programs. Granted, there was a modest public works component and support to states in Obama’s first year. But where is that now?

Compare two charts on the blog – and at the website demandsideforecast.net. One, the proportion of national income going to profits vs. wages. Two, debt by sector.

Whatever the causal links, you will see profits soaring, wage income plummeting, government debt ballooning, business debt sinking.

We propose the causal link is government policy. The Fed’s zero interest rates let corporations refinance and cut debt exposure, particularly in the financial sector which can now actually borrow at zero and lend back to the Treasury at more than zero and pocket the difference. Government deficits in the absence of private investment appear – as predicted or commanded, I guess you would say, by Minsky and Kelecki’s Algebra – appear in corporate profits.

Imagine for a moment government deficits that went to hiring people. It would take, say four hundred billion to bring the unemployment rate, the real unemployment rate, from 16 percent down to six percent. And the headline unemployment down to four. The same profits accrue in absolute terms, though as a percentage of GDP they would be lower because GDP would be higher.

We share Robert Frank’s amazement.

Anyway, there are the charts -— profits booming, deficits ballooning, returns to labor plummeting, business debt plunging.

Be sure, though, debt is trillions of dollars, tens of trillions of dollars, too high to be sustainable. We have that from Steve Keen. Read his Debtwatch Manifesto. link.

1 comment:

  1. The Philips curve link between employment and inflation may have held once, but there have been so many tweaks to employment laws that it means that it is meaningless. Governments have been almost criminal in their decision to use unemployment as a weapon to keep down the majority of workers yet do nothing about rising wages for executives. As for the definition of natural rate of unemployment I would challenge any figure that is about a couple of percent. A level that allows people to change jobs even with a break in-between jobs. This is a state that has not existed for more than forty years.