“Shake, Rattle & Roll”

Scott Sumner throws the “supply-side curve ball”:

But some Keynesians keep pretending that demand is the only problem facing the world.  It’s not; the supply side has been gradually deteriorating for more than a decade.  Brexit will make this problem even worse.

Meanwhile, Bernanke prevaricates:

Political outsiders have had quite a good year in the United States (and elsewhere), and many pundits have attributed their success to voters’ profound dissatisfaction with the economy. Certainly there is plenty to be dissatisfied about, including growing inequality of income and wealth and stagnation in real wages. But there are positives as well, including an improving labor market, low inflation, and low gasoline prices. How do people really feel about the U.S. economy?

[Unfortunately, all the “positives” are a consequence of his monetary policy errors]

And concludes:

In a highly polarized environment, with echo-chamber media, political debates often become shrill, and commentators and advocates have strong incentives to argue that the country’s future is bleak unless their party gains control. In this environment, it seems plausible that people will respond more intensely and negatively to open-ended questions about the general state of the country, while questions in a survey focused narrowly on economic conditions elicit more moderate responses. Without doubt, the economic problems facing the country are real, and require serious and sustained responses. But while perceptions of economic stress are certainly roiling our national politics, it may also be that our roiled politics are worsening how we collectively perceive the economy.

[More likely, it is the way we collectively perceive the economy that is shaking our politics]

For many years (decades in the case of the US and UK) before the “crisis”, the big developed economies (ex-Japan) were doing well. There was no suggestion of “new normal”, “great stagnation” or “depression”. The “supply-side” seemed just fine. Suddenly, almost as if central bankers were perfectly “coordinating”, those economies were walloped!

The first panel shows how central banks were de facto targeting NGDP-LT. The result was nominal stability (that includes low/stable inflation). Maybe because they thought they were targeting inflation, when oil prices pressured headline inflation they simultaneously freaked.

Shake Rattle & Roll_1

When central banks pulled up the hand brakes with force, the real economy was squeezed. As I argued here, the Fed (and the other central banks) seem to be happy with where the economies are. And if they are happy, that´s where they will stay, mired in depression. Note that the EZ central bank even acted more destructively, bashing a weekend economy over the head after it had already fallen to its knees.

Shake Rattle & Roll_2

Shake Rattle & Roll

If monetary policy could have avoided it, “Secular Stagnation” is a direct consequence of monetary policy!

Larry White has a very interesting post at Alt-M, where he uses Michael Darby´s 1976 analytical apparatus to do “Some Simple Monetarist Arithmetic of the Great Recession and Recovery” (you should read the post to enjoy the simplicity of the “apparatus”):

Monetarist theory sharply distinguishes real from nominal variables.  Nominal shocks (changes in the path of the money stock or its velocity) have only transitory effects on real variables like real GDP. Accordingly, an account of the path of real GDP in the long run (and 6+ years of recovery should be enough time to reach the long run) must be explained by real and not merely by nominal factors.  An account of the path of nominal GDP, by contrast, cannot avoid reference to nominal factors.  So we need distinct (but compatible) accounts of the two paths.

A downward displacement of the steady-state path of nominal GDP, due to a contractionary money supply or velocity shock, can bring a transitory decline in real GDP.  As is familiar, people try to remedy a felt deficiency in money balances by reducing their spending.  In the face of sticky prices, reduced spending generates unsold inventories and hence cutbacks in production and layoffs until prices fully adjust.  As Market Monetarists have long argued, the Federal Reserve could have avoided the downward displacement of the path of nominal GDP if policy-makers had immediately recognized and met the rise in fluidity (the drop in velocity) with appropriately sized expansionary monetary policy. 

Although a one-time un-countered rise in desired fluidity [inverse of velocity] can temporarily knock real GDP below course, such a nominal shock should not persistently displace its growth path, as the first chart above indicates has happened.  We can expect monetary equilibrium to be roughly restored by appropriate adjustment in the price level relative to the nominal money stock, bringing real balances up to the newly desired level, within three or four years at most.  (In the data plot above, we see the GDP deflator shift to a lower path already in 2009.)  Real GDP should around the same time return to its steady-state path as determined by non-monetary factors (labor force size and skills, capital stock, total factor productivity as governed by technologic improvements, policy distortions, and so on).  To explain the continued low level of real GDP relative to estimated potential since 2011 or so, we need a persistent shock to the path of real GDP.

I suggest that real GDP has shifted to a lower path because of a shrinkage in the economy’s productive capital stock — a problem that better monetary policy (not feeding the boom) could have helped to avoid, but cannot now fix.

Some comments:

The two highlighted passages seem contradictory. In the first, monetary policy failed to offset the rise in fluidity (fall in velocity) giving rise to the steep fall in NGDP.

In the second, he goes back in time to say the problem was excessively expansionary monetary policy that fed the boom.

I have a lot of trouble with the second claim (see here). But if you assume that´s true it becomes a double critique of monetary policy, having got it wrong in sequence, first in one direction and then the other.

The hysteresis argument that bad monetary policy shrank the economy´s capital stock (permanently lowering the path of real output) is hard to accept. After all, during the great depression, real output over a long span of time climbed back to the previous trend level, despite a much larger” shrinkage in the productive capital stock”. It seems a “review” of monetary pólicy had a lot to do with that outcome.


The next charts are also shown by Larry White, but I want to go into a bit more detail.



The sequence is clear. Economic events (house price fall, troubles with financial firms, among others) induced a strong rise (jump) in fluidity (drop in velocity). Money supply did not rise by anything close to necessary to offset the fall in velocity. The result was a (almost unheard of) fall in NGDP to a much lower level.

Later, from the end of 2010 to late 2011, maybe due to the Eurozone crisis, fluidity had another “step increase”, also not fully matched by the rise in money. The NGDP path ticks down.

More recently, with the path of fluidity steepening somewhat and the money supply trend remaining stable/constant, NGDP growth seems to falter.

What the horrendous monetary policy of the past eight or nine years has accomplished is “momentous”. From the successive reductions in the level of potential output estimated by the CBO over the past years, it seems that instead of “Mohamed (actual RGDP) going to the mountain (Potential RGDP), the mountain is coming down to Mohamed”!


In an LT world, “murder” is OK!

InTrade Deficits: These Times are Different”, Paul Krugman concludes:

But we are living in a world where, for the time being — and maybe for a long time to come, if secular stagnation theorists are right — mercantilism makes a fair bit of sense.

Oh my! PK must think that having a NP gives him a ‘license to kill”.

Fortunately, secular stagnation theorists seem to be wrong. Furthermore, appeals to liquidity traps is not convincing, As the charts show, World Trade Blues reflect a languishing global economy, i.e. weak global aggregate demand!


Recycling dead-end or wrong theories

Not being able to think ‘outside the box’, economists are recycling ‘theories’.

In recent days, two have ‘shot up (again) in the charts’: Secular Stagnation and Stagflation.

Maybe they´re not unrelated. David Andolfatto links them at the start of his recent post “Secular stagnation then and now”:

Secular stagnation refers to a prolonged and indefinite period of slow growth and high unemployment (or subnormal factor utilization). When was the last time this happened in the United States? Most people are likely to say the 1930s. In fact, it was the 1970s.

Also, when many, like Time, go for the “Secular Stagnation” moniker as in “This Theory Explains Why the U.S. Economy Might Never Get Better”:

These confounding circumstances have led many economists to rally behind the concept of so-called “secular stagnation.” As a diagnosis, secular stagnation is simple: It’s the idea that the economic problems the U.S. continues to face aren’t a product of the “business cycle,” the ebb and flow of boom times and recession (hence the “secular” part), but may well be permanent drags on the modern economy. “It’s a kind of long term and sustained slow-down in economic growth,” says Larry Summers, who served as Bill Clinton’s treasury secretary and is widely credited with dusting off the concept of secular stagnation and bringing it into the mainstream.

Others, like the WSJ, prefer to call it “Stagflation” as in “The U.S. may be heading for stagflation-lite—weak growth and accelerating price rises”:

One interpretation: the market is worried that growth will remain so-so while rising oil prices and incipient wage pressure force the U.S. Federal Reserve to tighten policy. Not exactly the stagflation of the 1970s, which ended in 1980 with inflation hitting 15% amid a recession. But a sort of stagflation-lite: weak growth and accelerating price rises.

“I think we are in a situation where [the Fed] might be forced to normalize rates because of inflation while the underlying economic momentum is slowing down and not capable of digesting higher rates,” said Jean Medecin, a member of the investment committee at Carmignac, a French fund manager.

A bit baffled by all this, Roger Farmer writes “Idiopathic Tardus Augmenti” and explains the title of his post at the end:

Ignorance is not a reason for embarrassment. When medical doctors do not understand the cause of a disease, they cloak their ignorance with Latin. An illness of unknown origin is ‘idiopathic’. Economists should adopt the same strategy. When growth is slow and we don’t know why, the economy is not experiencing secular stagnation. We are afflicted with a bout of idiopathic tardus augmenti

The facts: At least until 2006 the US has not experienced either “Secular Stagnation” or “Stagflation”!

Let´s look at some numbers (and charts)

  1. From 1890 to 2006, average real growth was 3.5%. Growth was very “choppy”, with a standard deviation (volatility) of 5.3 (Note that all the “choppiness” happens in the pre WWII period)


  1. From 1947 to 2006, real growth averaged a comparable 3.4% but was less than half as “choppy”, with a standard deviation of just 2.4


  1. From 1983 to 2006 (a “Great Moderation”) real growth averaged the same 3.4%, but “choppiness” was greatly reduced, with a standard deviation of only 1.4


Now, let´s take a closer look at the so-called “Stagflation” decade, the 1970s.

From 1970 to 1979, real growth averaged 3.3%, just a notch below the very long-term trend. “Choppiness”, at 2.5, was basically the same as that found for the 1947-2006 period (2.4).


As such, calling the 1970s “Stagflation” is a stretch! But there was certainly a lot of“Flation”!


Looking at the post “Great Recession” of 2007-09, from 2010 to the present real growth averaged a much lower 2.1% with almost non existant volatility (standard deviation of 0.5). That may certainly “qualify” as a (still short) period of “stagnation” (maybe not “secular”). It´s better described as a “flat sea at low tide”.


But there´s certainly no “flation” to go along with the “stag”, as the WSJ calls it! A flat sea at low tide is not known to produce “surfer-friendly waves”!


One important implication: If you´re going to talk about “Secular Stagnation”, don´t look to the past for guidance. The reasons must be found in the present!

“Secular Stagnation! Larry Summers is wrong”

Roger Farmer posts: “Secular Stagnation! Larry Summers is right

Larry Summers has once again been advancing the secular stagnation hypothesis. David Andolfatto responds with this tweet which plots GDP per person in the United States since the late nineteenth century. I’m with Larry on this one.

Why does this matter and what does it have to do with secular stagnation? Those who would deny the secular stagnation hypothesis want you to believe that the economy has a very strong tendency to revert to a mean growth path which is independent of shocks. Leave the economy to itself, and the recuperative powers of the market will restore us to the social optimum. The secular stagnationists, and I am one of them, disagree.

We believe that, in the absence of corrective policies by the central bank or the treasury, the economy will never recover after a shock. The unemployment rate will not revert to its social optimum and, associated with that fact, the economy will never revert to its optimum growth path. After a shock, the data do not revert to the same trend that they followed before the shock hit.

GDP per person has a unit root. That is accepted by everyone who has studied these data. The interesting question is why?

If, as Robert Gordon believes, it is caused by random technology shifts then there is not much that monetary policy or macro prudential policies can do about it. If, as I believe, it is caused by random movements from one inefficient equilibrium to another, we should be thinking very hard about how to design a monetary/macro-prudential policy that keeps the economic train on the tracks.

I´m closer to Andolfatto. Furthermore, Farmer´s allegation that “a unit root in GDP per person is accepted by everyone is false! He links to a Cochrane 1988 paper. These two links (here and here) indicate “everyone” is not really everyone!

The chart below takes the post WWII years. I estimate the trend from 1950 to 1994 and project for the next 20 years. GDP per person remains on trend up to 2007, after which it drops AND stays down.

Farmer SS_1

During the late 1960s and throughout the 1970s, the economy was buffeted by significant demand (fiscal) and real (oil) shocks. Monetary policy was lousy (the reason behind the period getting named “Great Inflation”). Nevertheless, the chart indicates that real GDP per person always reverted to trend, contrary to what Farmer presumes.

During the “Great Moderation”, output per person hugged very closely to the trend, with little oscillation. That was broken in 2008 and for the past 7 years GDP per person has evolved far below trend. It´s not really a “Great Stagnation”, but a “depression” (even if it´s not “Great”).

I agree with Farmer that we should “thinking very hard about how to design a monetary policy that keeps the economic train on the tracks”. Market Monetarist´s suggestion is that monetary policy should strive to obtain nominal stability, in other words, keep NGDP evolving close to a level trend path.

The NGDP growth chart illustrates

Farmer SS_2

Update: Jérémie Cohen Setton at Bruegel has a take:

What’s at stake: The question of whether capitalist economies are self-correcting and will eventually revert to mean growth has received renewed interest given the underperformance of most economies six years after the onset of the Great Recessions. While the idea of persistent high unemployment was central to Keynes’ General Theory, it was quickly abandoned by the neoclassical synthesis.

Tyler Cowen writes that the most crucial issue is whether economies will return to normal conditions of steady growth, or whether we are witnessing a fundamental transformation, unveiled in bits and pieces. One relatively optimistic view is that observed deficiencies — like slow growth in real wages and the overall economy, persistently low interest rates and low levels of labor participation — are merely temporary.  Another commonly heard view is that we made the mistake of letting the last recession linger too long, allowing some of its features to become entrenched.



Bernanke´s GSG hypothesis: A cop-out

Bernanke and Summers just call the same “idea” by different names. To Bernanke it´s “Savings Glut”. To Summers it´s “Secular Stagnation”. In his “A Response to Bernanke“, Summers writes: “The essence of secular stagnation is a chronic excess of saving over investment”.
I figured I could reblog this old post dealing with Bernanke´s GSG hypothesis and that would also cover Summers´arguments.


Bernanke is at it again. In a speech last friday and in a new paper, he gives new life to the global savings glut hypothesis (GSG) that he first put forth in 2005 as an explanation for Greenspan´s “Conundrum” (the fact that after mid 2004, with the Fed increasing the policy rate (FF), long term rates “stayed put”). This time he extends his original arguments by considering the type of assets desired by the emerging economies (the savers) as they recycled their dollar reserves into US investments.

Indirectly, this discussion, which has been going on for several years, smacks of an effort to absolve the Fed from responsibility for the financial crisis which erupted with the bursting of the house bubble. For many (see this post by David Beckworth), bad monetary policy in 2002-04 (“rates too low for too long”) is a major factor behind the housing boom…

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Hiding behind “Secular Stagnation”

Scott Sumner comments on a post by Edward Hugh:

The focus of Hugh’s piece is Finland.  He points to the very weak recovery, and suggests that structural factors are involved. Perhaps so, but some of the data he cites point in exactly the opposite direction.  Finnish unemployment has been rising, and at 9.2% is at the highest rate in more than a decade.  Meanwhile Hugh’s post shows inflation in Finland falling to zero. Those data points suggest a lack of aggregate demand, not structural problems.

EH shows several charts to further his “secular stagnation” claims. One chart he doesn´t show is a comparative chart of nominal spending (NGDP) relative to trend. I do so below and add Austria and Spain as “evidence” of the degree of the AD shortfall in Finland.


Every country in the world could do with some structural reforms, some more, some less, but the big problem with most of those economies, as exemplified by the charts for the three countries above, where all are subject to the same monetary policy, is differing degrees of  aggregate demand shortfall.