Thanks to those of you who have tried out the preview draft version of the How the Economy Works Visual Tutorial and submitted feedback! (And thanks Tom for the extra traffic from your post).
I have created a dedicated blog for EconViz.org on which I'll announce major content and functionality updates to that site. Feel free to subscribe to the RSS Feed if you are interested in seeing what unfolds there and perhaps giving further feedback. So far there are two posts -- an introduction, and the results of the mini-survey I included at the end of the tutorial.
My goal is to keep up occasional posts on this blog on macroeconomics topics outside of concept visualization -- hopefully more frequent than they have been recently! But neither will be a high volume blog any time soon.
Public Service Announcement for Google Reader users: If like me you were driven crazy by the huge amount of wasted screen space in the "refresh" to Google Reader a few weeks ago, I recommend the Google Reader Demarginfier script (works with the Greasemonkey browser add-on).
Tuesday, November 22, 2011
Wednesday, November 16, 2011
Concept Visualization and Macroeconomics
Across many theoretical subjects, it seems that much more effort has been spent on data visualization than on concept visualization. There are a number of good reasons for this, but I think concept visualization is still behind where it should be (at least in the educational material I've been exposed to).
Macroeconomics is a subject extremely well suited to conceptual visualization, yet the majority of the educational material on the web seems to be text-centered (other than supply-demand curves and the occasional simple diagram or balance sheet). While equations such as “GDP = C + I + G + ( X – M )” provide precision and rigor and aren't even mathematically complex, their inclusion in content (for example, blog posts) necessarily narrows the potential audience.
As most readers know, my first attempt at concept visualization for macroeconomics was the Macroeconomic Balance Sheet Visualizer. However, it did not appear to be as accessible to newcomers as I'd initially hoped. So I've been working on something intended for a broader audience.
Design goals include:
My “to do” list is enormous for it... there is much much more that can be done graphically as well with better verbal coverage of concepts. It simply takes time... And you'll also have to excuse the amateurish graphics, for now.
That said, it's very useful to get feedback to help prioritize the “to do” list, plus you may have creative suggestions that aren't on my list! Also I hope you'll help keep me on track with direct and honest feedback (including negative reactions) if you think parts of it are heading in the wrong direction, or I've messed up or left out important things! If you do choose to try this new visualizer and respond, you can give anonymous feedback directly from a link at the bottom of each page in the tutorial, or you can post comments to this blog post, or email me.
And if you're just learning MMT and are short on time, you may want to just wait for a future improved version rather go through what's there now, since it's full of gaps and placeholders.
Here it is:
http://econviz.org/how-the-economy-works-visual-tutorial/
P.S. I do still have a good sized list of potential topics for this blog too, but have still been giving the EconViz stuff priority for the time being, so please excuse the silence.
Macroeconomics is a subject extremely well suited to conceptual visualization, yet the majority of the educational material on the web seems to be text-centered (other than supply-demand curves and the occasional simple diagram or balance sheet). While equations such as “GDP = C + I + G + ( X – M )” provide precision and rigor and aren't even mathematically complex, their inclusion in content (for example, blog posts) necessarily narrows the potential audience.
As most readers know, my first attempt at concept visualization for macroeconomics was the Macroeconomic Balance Sheet Visualizer. However, it did not appear to be as accessible to newcomers as I'd initially hoped. So I've been working on something intended for a broader audience.
Design goals include:
- Anchor as much of the verbal content to visual representations as possible, to reduce ambiguity and help illustrate concepts
- Be as concise as possible while covering the most important core concepts
- Have the core content be beginner friendly, but have additional details available just a click away at each step along the path for those who want more
- Use a web site rather than blog format, so the content can be evolved and improved in-place over time
My “to do” list is enormous for it... there is much much more that can be done graphically as well with better verbal coverage of concepts. It simply takes time... And you'll also have to excuse the amateurish graphics, for now.
That said, it's very useful to get feedback to help prioritize the “to do” list, plus you may have creative suggestions that aren't on my list! Also I hope you'll help keep me on track with direct and honest feedback (including negative reactions) if you think parts of it are heading in the wrong direction, or I've messed up or left out important things! If you do choose to try this new visualizer and respond, you can give anonymous feedback directly from a link at the bottom of each page in the tutorial, or you can post comments to this blog post, or email me.
And if you're just learning MMT and are short on time, you may want to just wait for a future improved version rather go through what's there now, since it's full of gaps and placeholders.
Here it is:
http://econviz.org/how-the-economy-works-visual-tutorial/
P.S. I do still have a good sized list of potential topics for this blog too, but have still been giving the EconViz stuff priority for the time being, so please excuse the silence.
Thursday, August 25, 2011
Looking for a Volunteer
As previously mentioned, I've been gradually working on a new MMT-inspired visual tutorial on how the economy works. (It is completely separate from the macroeconomic balance sheet visualizer). My hope has been that integrating an animated flow diagram alongside the verbal explanations would make the concepts accessible to a broader audience than those willing to read and digest a typical MMT blog post.
I have a partial "proof of concept" working, though it's still too rough, ugly, and incomplete to release into the public wilds of the internet.
I would value high level directional feedback on what is working well and what isn't. Please email me privately if you'd be willing to take a look and give feedback. It could be especially helpful if you are either:
I have a partial "proof of concept" working, though it's still too rough, ugly, and incomplete to release into the public wilds of the internet.
I would value high level directional feedback on what is working well and what isn't. Please email me privately if you'd be willing to take a look and give feedback. It could be especially helpful if you are either:
- someone who has experience attempting to explain MMT to others, or
- someone who is learning MMT and still trying to get up to speed on the core concepts.
Wednesday, June 22, 2011
A Visual Guide to Endogenous Money and the Failure of QE
I've wanted to do a more comprehensive post on the dynamics of endogenous money and the private sector's response to large exogenous events such as quantitative easing, but for now this post will be another incremental update to my previous posts on the topic from October and April. As stated previously, it's possible I've reached some incorrect conclusions, however my interpretation of a piece of Post-Keynesian Circuitist literature I was referred to suggests to me that these ideas are on the right track.
Basic QE Mechanics
Some people have read that the direct mechanics of Quantitative Easing only increase bank reserves but not deposits (broad money supply). That is true only in the narrow case where banks are net sellers of bonds from their own balance sheets to the Federal Reserve. But the evidence suggests banks have not drawn down their net bond assets in this way since QE began (the Fed has bought over $2 trillion in bonds!), and that the primary sellers are non-banks. To see why the immediate mechanical result of this is for QE to increase bank deposits (and thus broad money supply), please visit the Macroeconomic Balance Sheet Visualizer and run the operation "Quantitative Easing (Variation 1 - Households Sell)". Also, see this guide from the NY Fed:
Actual Broad Money Supply Changes During QE
The first graph shows broad money supply as measured by MZM (Money Zero Maturity), the second graph shows the year on year change.
It's not obvious that either QE program had a direct impact on the broad money supply trends, even though they should have if you consider only the direct mechanical results of the Fed buying bonds, and don't consider any private sector response! Of course it is difficult to tell for sure, as the money supply changes for lots of reasons besides just QE (e.g., it generally expands during economic growth, but perhaps also during times of uncertainty).
So where did part of the roughly $2 trillion in "money" that replaced bonds go? Did it only "disappear" to the extent that the private sector wanted to pay down debt? I've argued that it disappeared INDEPENDENTLY of whatever level of desire there was to pay down debt, and that the money supply growth that did occur would have occurred to almost the EXACT SAME DEGREE even if QE had not happened. In other words, money supply grew because the private sector "wanted" a larger money supply as part of its aggregated portfolio preferences.
A Visual Guide to Money Supply Endogeneity
First, consider the general situation in which bank loans expand the broad money supply. The "Bank Loans" and "Bank Credit" bars are the same size by identity because loans create deposits:
Next, consider what happens during Quantitative Easing in terms of the immediate mechanical result. Broad money supply expands, "backed" by an increase in excess reserves held by the banking system:
The private sector controls all quantities with white labels. Excess reserves, with a yellow label, is the only quantity here fully controlled by government! The light yellow label on Required Reserves indicates partial control. Banks lend first and look for needed reserves later, and the Federal Reserve's open market operations ensure that reserves sufficient to meet reserve requirements will automatically become available (either as a result of the Fed buying/selling treasuries as part of OMO, or via loans from the Fed). So the quantity of Required Reserves adjusts in response to changes in the quantity of Bank Loans, and the government only controls the size of Required Reserves if it changes the rules.
Lastly, consider how the private sector can work to "undo" the change in money supply imposed by QE, without having to alter its borrowing desires!
One of the reasons bank loans can be replaced by other forms of borrowing (perhaps with a lag?) is that when you look inside the aggregates, the economy is very dynamic under the surface. There are always some households and companies borrowing new money, others making debt repayments and others completely paying off debt.
Some bank loans may be repaid early and replaced by non-bank borrowing, but in general there is always new borrowing being done, even when the big picture is one of deleveraging.
When there is "excess" money and investors would rather hold bond assets, those investors will likely outbid banks in the contest to fund new borrowing needs. That is how the mix of bank debt versus non-bank debt can be affected. Even unconventional borrowing markets may play a part in this, such as "peer-to-peer" lending (going to family and friends for a loan instead of to the local bank). Another example of non-bank borrowing is new corporate equity issuance — perhaps angel investors and the like are outbidding banks on meeting funding needs, too.
Overview of Ways the Private Sector Can Reduce "Unwanted" Broad Money Supply:
Why does this matter? To the extent that these dynamics really occur as described in my three posts so far:
Basic QE Mechanics
Some people have read that the direct mechanics of Quantitative Easing only increase bank reserves but not deposits (broad money supply). That is true only in the narrow case where banks are net sellers of bonds from their own balance sheets to the Federal Reserve. But the evidence suggests banks have not drawn down their net bond assets in this way since QE began (the Fed has bought over $2 trillion in bonds!), and that the primary sellers are non-banks. To see why the immediate mechanical result of this is for QE to increase bank deposits (and thus broad money supply), please visit the Macroeconomic Balance Sheet Visualizer and run the operation "Quantitative Easing (Variation 1 - Households Sell)". Also, see this guide from the NY Fed:
"When the Fed buys an asset, the effect on the broad money supply depends on who sold the assets and what they do with the funds they receive. If the seller is a bank, reserves go up, but broad money only increases if the bank responds to the increase in its reserves by lending more to households and businesses. If the seller is an investor other than a bank, reserves go up, and broad money also goes up in the first instance as the seller's bank puts a sum equal to the amount it receives from the Fed into the seller's bank account. But if the seller uses the money to pay down debt, the broad money supply declines again by the amount of the debt repayment. As of early 2011, the behavior of the broad money supply, economic activity and inflation all suggested that recent money growth had not been excessive."The guide mentions the well known idea that the broad money supply increase resulting from QE has been muted due to debt repayment, but as my past posts have indicated, I think that's only half the story.
Actual Broad Money Supply Changes During QE
The first graph shows broad money supply as measured by MZM (Money Zero Maturity), the second graph shows the year on year change.
It's not obvious that either QE program had a direct impact on the broad money supply trends, even though they should have if you consider only the direct mechanical results of the Fed buying bonds, and don't consider any private sector response! Of course it is difficult to tell for sure, as the money supply changes for lots of reasons besides just QE (e.g., it generally expands during economic growth, but perhaps also during times of uncertainty).
So where did part of the roughly $2 trillion in "money" that replaced bonds go? Did it only "disappear" to the extent that the private sector wanted to pay down debt? I've argued that it disappeared INDEPENDENTLY of whatever level of desire there was to pay down debt, and that the money supply growth that did occur would have occurred to almost the EXACT SAME DEGREE even if QE had not happened. In other words, money supply grew because the private sector "wanted" a larger money supply as part of its aggregated portfolio preferences.
A Visual Guide to Money Supply Endogeneity
First, consider the general situation in which bank loans expand the broad money supply. The "Bank Loans" and "Bank Credit" bars are the same size by identity because loans create deposits:
Next, consider what happens during Quantitative Easing in terms of the immediate mechanical result. Broad money supply expands, "backed" by an increase in excess reserves held by the banking system:
The private sector controls all quantities with white labels. Excess reserves, with a yellow label, is the only quantity here fully controlled by government! The light yellow label on Required Reserves indicates partial control. Banks lend first and look for needed reserves later, and the Federal Reserve's open market operations ensure that reserves sufficient to meet reserve requirements will automatically become available (either as a result of the Fed buying/selling treasuries as part of OMO, or via loans from the Fed). So the quantity of Required Reserves adjusts in response to changes in the quantity of Bank Loans, and the government only controls the size of Required Reserves if it changes the rules.
Lastly, consider how the private sector can work to "undo" the change in money supply imposed by QE, without having to alter its borrowing desires!
One of the reasons bank loans can be replaced by other forms of borrowing (perhaps with a lag?) is that when you look inside the aggregates, the economy is very dynamic under the surface. There are always some households and companies borrowing new money, others making debt repayments and others completely paying off debt.
Some bank loans may be repaid early and replaced by non-bank borrowing, but in general there is always new borrowing being done, even when the big picture is one of deleveraging.
When there is "excess" money and investors would rather hold bond assets, those investors will likely outbid banks in the contest to fund new borrowing needs. That is how the mix of bank debt versus non-bank debt can be affected. Even unconventional borrowing markets may play a part in this, such as "peer-to-peer" lending (going to family and friends for a loan instead of to the local bank). Another example of non-bank borrowing is new corporate equity issuance — perhaps angel investors and the like are outbidding banks on meeting funding needs, too.
Overview of Ways the Private Sector Can Reduce "Unwanted" Broad Money Supply:
- Replace loans (which create money) with non-bank borrowing (which does not create money) independent of total debt levels. Examples of non-bank debt include corporate bonds, peer to peer loans, securitized loan pools, housing agency debt, etc. Most of this post focused on this mechanism.
- Induce less bank lending by changing aggregated propensities to borrow. For example, many reports indicate a record number of cash buyers have been supporting the housing market. Logically, if there is an "excess" of deposits in the economy, then investors who would rather own other assets may outbid other potential buyers of those same assets who would have bought using debt. Thus, while QE's added money supply in this case doesn't eliminate existing bank loans, it serves to reduce the number of houses bought using bank loans, while at the same time other loans are continually being paid down. The net effect is that bank lending moves to a lower level than it would have been at had QE not occurred. Those who lost the bid for houses (who would otherwise have bought with a bank loan) might rent from the investors instead, so this point does not imply that QE will cause some to have no place to live.
- Banks can sell assets (treasuries, loans, etc) to the rest of the private sector. A net decrease in assets in this way causes a net decrease in broad money supply. To see how this works, visit the Macroeconomic Balance Sheet Visualizer, and choose the operation "Bank Loan" followed by "Bank Loan is Securitized" (which is one way banks sell assets to the non-bank sector).
- Banks can fund themselves with a higher portion of non-deposit liabilities (e.g., bonds) instead of deposit liabilities. This results in less broad money supply. As I understand it, this was part of the dynamic that RSJ described in this post.
Why does this matter? To the extent that these dynamics really occur as described in my three posts so far:
- This shows in even stronger terms why Quantitative Easing as practiced so far (targeting quantities rather than prices) has had no meaningful effect other than on sentiment. QE truly was a placebo.
- It lends even more power to the concept that money is always debt and can NOT be modeled like a commodity. Its quantity is extremely dynamic and subject to the portfolio desires of the private sector. IS/LM curves and the like are not relevant. One of the arguments by the Fed was that QE would increase deposits in portfolios relative to the supply of available bonds and provide a bid under other assets due to "formulaic" institutional portfolio investing, but the premise of persistently expanded money supply and reduced longer duration assets appears to be false.
- It lends even more weight to the idea (frequently argued by MMTers) that interest rates are determined independently of borrowing demand, and thus that there can be no financial crowding out of the private sector when the government issues debt! Economy-wide interest rates truly are anchored to the short term Fed Funds rate plus expectations of future rate settings. (Not that the market can always consistently estimate future rate settings!)
- Conventional wisdom is that one goal of QE was to help the banking system. Ironically, QE may have hurt banks more than it helped them! The banking system seems to operate as a private sector lender of last resort, and by triggering a shift to additional direct (non-bank) lending, QE seems to have reduced the role of banks in the economy, and thus reduced their potential to accrue earnings from loans!
Some Thoughts on US Economic Growth
Here is an updated chart from a previous post (Real GDP Growth in the US and Japan: A Closer Look at Consumption, Government Spending, Net Exports, Investment, and Inventories).
US: Contributions to Percent Change in Real Growth Domestic Product (2005/Q1 - 2011/Q1)
US: Contributions to Percent Change in Real Growth Domestic Product (2005/Q1 - 2011/Q1)
(click to enlarge)
Note that 2010-2011(Q1) does not look all that different from 2005-2007!
I don't know where to from here. I think a "double dip" is very possible but if I had to guess, I don't think a new recession is the most probable scenario in the near term. But that depends on difficult factors to predict such as whether current US congressional antics really are only short term theater as many allege, and the potential size of negative demand shocks from the rest of the world (China, Europe, other various housing bubble countries like Australia and Canada, etc).
I believe a common mistake is to consider high oil prices to be one of the drags on growth. Rising oil prices are certainly a drag on growth, but stable oil prices (once lagged effects of previous changes have dissipated) are growth neutral, as I understand it. Even the generally excellent Calculated Risk might have gotten this wrong in a recent outlook post where he says "Also the recent decline in oil and gasoline prices will help, although $100 oil is still a drag on the economy." However he could be correct if he considers a drag on the economy to be a separate phenomenon from a drag on economic growth. (If you think I'm the one who's gotten this wrong, please let me know!)
Similarly, deleveraging is not a drag on growth unless the rate of deleveraging increases. Deleveraging is just one determinant of the household savings rate. A stable household savings rate is growth-neutral. However, deleveraging does reduce the likelihood of a falling savings rate and the associated boost to GDP growth that such a shift would provide. So in terms of current economic growth (i.e., ignoring impacts on future growth), steady-state deleveraging is the absence of a positive rather than an actual negative.
Note that this post only focused on GDP growth... clearly we still have crisis levels of unemployment and underemployment that policy makers should be actively working to address!
I don't know where to from here. I think a "double dip" is very possible but if I had to guess, I don't think a new recession is the most probable scenario in the near term. But that depends on difficult factors to predict such as whether current US congressional antics really are only short term theater as many allege, and the potential size of negative demand shocks from the rest of the world (China, Europe, other various housing bubble countries like Australia and Canada, etc).
I believe a common mistake is to consider high oil prices to be one of the drags on growth. Rising oil prices are certainly a drag on growth, but stable oil prices (once lagged effects of previous changes have dissipated) are growth neutral, as I understand it. Even the generally excellent Calculated Risk might have gotten this wrong in a recent outlook post where he says "Also the recent decline in oil and gasoline prices will help, although $100 oil is still a drag on the economy." However he could be correct if he considers a drag on the economy to be a separate phenomenon from a drag on economic growth. (If you think I'm the one who's gotten this wrong, please let me know!)
Similarly, deleveraging is not a drag on growth unless the rate of deleveraging increases. Deleveraging is just one determinant of the household savings rate. A stable household savings rate is growth-neutral. However, deleveraging does reduce the likelihood of a falling savings rate and the associated boost to GDP growth that such a shift would provide. So in terms of current economic growth (i.e., ignoring impacts on future growth), steady-state deleveraging is the absence of a positive rather than an actual negative.
Note that this post only focused on GDP growth... clearly we still have crisis levels of unemployment and underemployment that policy makers should be actively working to address!
Thursday, April 21, 2011
Further Evidence that the Private Sector Fully Controls the Money Supply and QE Doesn't "Work" as Advertised
In October, I wrote a post titled How the Loan/Bond Choice Helps the Private Sector Self-Determine the Money Supply — AND Yet Another Reason QE is a Non-Event for the Economy. To give a brief summary, it described my thoughts on the inter-relational dynamics between debt, money supply, and Quantitative Easing, as follows:
Possible Evidence from a Post-Keynesian Expert that this Theory may be Correct
In the comments of my previous post, commenter Ramanan helpfully linked to a PDF from Marc Lavoie, one of the leading Circuitists. Circuitists (also known as horizontalists) are one "school" of theory within Post-Keynesian economics, and they share most of the same concepts as Modern Monetary Theorists. In section 9.3.1, Lavoie seems to describe the same dynamic that I have attempted to describe. Here is an excerpt:
For reasons that are unclear to me, some MMT authors repeatedly claim that QE does not add to the broad money supply. While it is true that if the primary dealers sell their own treasuries to the Fed, then only base money supply is affected, this scenario is too limited given the size of QE to date. As I understand it, primary dealers frequently act as an intermediaries to facilitate QE buying assets from the larger private sector. But if the private sector can react relatively quickly enough via the mechanisms described here to "undo" the money supply changes, then the money supply data won't show any bulge in broad money supply resulting from QE! (And of course there are other factors impacting the money supply at the same time, primarily a desired deleveraging within the private sector, so it is probably not possible to disentangle these different dynamics when looking at the data.)
Evidence in the Recent Data for the QE in the United States
In the last post on this topic, I showed a graph of Japan's bank and non-bank borrowing. While inconclusive, it suggests that Japan's Quantitative Easing from 2001-2006 may have caused a relative decrease in bank-based borrowing as compared to non-bank borrowing, which could add to evidence of the theories above.
Below is a graph of US borrowing from Q2 2004 to Q1 2011.
Effects of US Quantitative Easing on Bank Lending Compared to Total Borrowing:
The red line shows the annualized percentage change in bank loans and leases, by quarter. The green line shows the annualized percentage change in total private sector debt (from the Z.1 report, which is not yet available for Q1 2011). The blue line shows the annualized percentage change in non-financial private sector debt (since the private sector's debt has many layers that could overwhelm the other trends, I thought it worth separating financials out.) I have not subtracted bank loans out of the total debt data, so the shape of the blue and green lines is slightly impacted by the shape of the red line (though the absolute amount of bank debt is around $7 trillion versus around $41 trillion for total private sector debt, so crossover impact is not huge).
Notice how bank loans declined substantially faster than total debt after the first round of Quantitative Easing started! The gap between the red line and the blue line is probably the most relevant. Despite tracking closely to each other until late 2008, they diverged significantly starting in 2009, perhaps as the private sector favored non-bank lending on a relative basis over bank lending, in order to "shed" the excess money supply imposed by quantitative easing!
The second round of quantitative easing is smaller in magnitude, and the data so far only covers the start of QE2. However, in Q4 2010 the gap between the red and blue lines appears to begin widening again. Will that effect continue? I would guess so, but I could ultimately prove to be wrong.
It is also not clear how big the lag effects in this process are. Also, the changes in bank loans versus total debt diverged most significantly in the middle of QE1, and the gap narrowed partially before QE1 ended. It could be that other dynamics that I am unaware of provide a more accurate explanation than what I suggest here.
Anecdotal Evidence
While it's far from scientific or conclusive, and I don't follow the details of specific financial markets, I occasionally see anecdotal evidence of the private sector's increased eagerness for non-bank lending. For example:
In generating the chart in this post, I discovered the importance of using the percent change bank loan data as prepared by the Federal Reserve in its H.8 release whenever possible, instead of starting with the absolute levels of loans. The latter's level jumps around too much due to balance sheet consolidations, acquisitions, etc, while the percent change data appears to be adjusted to remove this effect, if I am understanding it correctly. Details are on the about page and notes page.
- There are two high level ways that borrowing occurs in the private sector — bank loans, and all other forms of borrowing, i.e., bond issuance, securitization, peer to peer lending, etc.
- When there is an "excess" of short duration assets (primarily money) held by the private sector, the holders of those assets will be eager to lend it out, and thus acquire a higher yielding asset. The money supply remains unchanged.
- When there is no "excess" of money to lend (i.e., portfolio preferences are satisfied with the current levels), then banks will have a higher propensity than non-bank lenders to fulfill the economy's current borrowing needs, because they can lend an [almost] unlimited amount, independent of their level of money/reserves. (Their only limit on lending to worthy borrowers, and it is temporary, is how much equity capital they can raise). Bank lending increases the money supply, so from a macro perspective, banks could be considered the private sector's lender of last resort.
- By choosing the relative proportion of the two type of borrowing, the private sector is able to choose its portfolio mix of long duration assets and short duration assets (money), independently of the actions of the federal government, and [mostly] independently from the desired level of private sector borrowing!
- When the Federal Reserve conducts Quantitative Easing, it buys long duration assets (treasury bonds, etc) out of the private sector, and gives the private sector short duration assets (money balances) instead.
- If the private sector is not happy with this new portfolio mix resulting from QE, it likely has the power to "undo" the change over time via shifts in the proportion of bank loans versus other types of lending that it uses!
Possible Evidence from a Post-Keynesian Expert that this Theory may be Correct
In the comments of my previous post, commenter Ramanan helpfully linked to a PDF from Marc Lavoie, one of the leading Circuitists. Circuitists (also known as horizontalists) are one "school" of theory within Post-Keynesian economics, and they share most of the same concepts as Modern Monetary Theorists. In section 9.3.1, Lavoie seems to describe the same dynamic that I have attempted to describe. Here is an excerpt:
"...for apparently the demand for money and the supply of credit are determined by two independent mechanisms. In the Lavoie and Godley (2001-2002) model for instance, the demand for credit, at the end of the period, depends on the part of investment expenditures which has not been financed by retained earnings and new equity issues..."
"...the decision by households to hold on to more or less money balances has an equivalent compensatory impact on the loans that remain outstanding on the production side."While Lavoie only mentions "equity issues", I have seen evidence elsewhere that he uses that term as shorthand to describe any non-bank borrowing mechanism employed by a firm, i.e., his reference to "equity issues" is supposed to also encompass bond issues and some other types of liabilities.
For reasons that are unclear to me, some MMT authors repeatedly claim that QE does not add to the broad money supply. While it is true that if the primary dealers sell their own treasuries to the Fed, then only base money supply is affected, this scenario is too limited given the size of QE to date. As I understand it, primary dealers frequently act as an intermediaries to facilitate QE buying assets from the larger private sector. But if the private sector can react relatively quickly enough via the mechanisms described here to "undo" the money supply changes, then the money supply data won't show any bulge in broad money supply resulting from QE! (And of course there are other factors impacting the money supply at the same time, primarily a desired deleveraging within the private sector, so it is probably not possible to disentangle these different dynamics when looking at the data.)
Evidence in the Recent Data for the QE in the United States
In the last post on this topic, I showed a graph of Japan's bank and non-bank borrowing. While inconclusive, it suggests that Japan's Quantitative Easing from 2001-2006 may have caused a relative decrease in bank-based borrowing as compared to non-bank borrowing, which could add to evidence of the theories above.
Below is a graph of US borrowing from Q2 2004 to Q1 2011.
Effects of US Quantitative Easing on Bank Lending Compared to Total Borrowing:
(click to enlarge)
The red line shows the annualized percentage change in bank loans and leases, by quarter. The green line shows the annualized percentage change in total private sector debt (from the Z.1 report, which is not yet available for Q1 2011). The blue line shows the annualized percentage change in non-financial private sector debt (since the private sector's debt has many layers that could overwhelm the other trends, I thought it worth separating financials out.) I have not subtracted bank loans out of the total debt data, so the shape of the blue and green lines is slightly impacted by the shape of the red line (though the absolute amount of bank debt is around $7 trillion versus around $41 trillion for total private sector debt, so crossover impact is not huge).
Notice how bank loans declined substantially faster than total debt after the first round of Quantitative Easing started! The gap between the red line and the blue line is probably the most relevant. Despite tracking closely to each other until late 2008, they diverged significantly starting in 2009, perhaps as the private sector favored non-bank lending on a relative basis over bank lending, in order to "shed" the excess money supply imposed by quantitative easing!
The second round of quantitative easing is smaller in magnitude, and the data so far only covers the start of QE2. However, in Q4 2010 the gap between the red and blue lines appears to begin widening again. Will that effect continue? I would guess so, but I could ultimately prove to be wrong.
It is also not clear how big the lag effects in this process are. Also, the changes in bank loans versus total debt diverged most significantly in the middle of QE1, and the gap narrowed partially before QE1 ended. It could be that other dynamics that I am unaware of provide a more accurate explanation than what I suggest here.
Anecdotal Evidence
While it's far from scientific or conclusive, and I don't follow the details of specific financial markets, I occasionally see anecdotal evidence of the private sector's increased eagerness for non-bank lending. For example:
- Junk Borrowers Turn Tables on Investors With Looser Terms: Credit Markets: "...debt sold this week included a condition that allows the company to call 10 percent of the bonds at 103 cents on the dollar in each of the first four years... [The borrower] is trying to lock in low interest rates while getting the flexibility to repay debt any time, as it would with a loan..."
- Subprime Bonds Are Back
- [Maybe] recent increases in venture capital activity? (If true, it would be an example of equity issuance rather than bond issuance, but with a similar macroeconomic effect.)
In generating the chart in this post, I discovered the importance of using the percent change bank loan data as prepared by the Federal Reserve in its H.8 release whenever possible, instead of starting with the absolute levels of loans. The latter's level jumps around too much due to balance sheet consolidations, acquisitions, etc, while the percent change data appears to be adjusted to remove this effect, if I am understanding it correctly. Details are on the about page and notes page.
Tuesday, April 12, 2011
Real GDP Per Capita and Myths about Japan's Stagnation
While addressing some myths about Japan, Bill Mitchell posted some graphs of contributions to real GDP. His graphs cover the same data I graphed last August -- the contributions of Consumption, Investment, Government Spending, and Net Exports toward inflation-adjusted economic growth. (A minor difference is I separated Inventories and other Investment in my graphs). Bill also usefully added in Ireland while emphasizing the negative effects of austerity on growth. Visuals such as these make it obvious that investment falls under austerity -- it doesn't rise on a supposed swell of increased business confidence that austerity proponents often claim will be triggered!
While I've been guilty of parroting some myths on Japan myself in years past, it has been enlightening to put more effort into reviewing the data for myself. Here is a graph I have been meaning to post for quite a while:
Annual Growth of Real GDP Per Capita in the US and Japan (1980-2009)
The blue line is for Japan, the red line for the US. It is quite astonishing how close in both magnitude and direction US and Japanese growth have been, when adjusted for population changes! The main divergences are Japan's burst of higher growth in the late 1980s, and its austerity-driven recession in the late 1990s. Once you adjust real GDP growth for changes in population, what you are left with is largely productivity growth. There are other factors that affect the level of GDP (and important things like employment!) but they have less effect on year-on-year growth rates once the adjustment has occurred.
Japan's famous deleveraging primarily meant a higher savings rate than before the deleveraging (corporate rather than household, in Japan's case), with the main effect being a one time shift downward in GDP level (but not growth). After the GDP shift caused by a savings rate shift, future and ongoing GDP growth is impacted by other factors such as whether aggregate demand is sufficient to bring growth back near potential growth, but Japan may have been a success story in this area! However, its success in achieving this real per-capita GDP growth may have been more a result of the falling household savings rate over the last couple decades than of government fiscal (or monetary!) policy.
Japan's stagnation myths (some people blame too much government spending, others too little!) derive in part from two sources of confusion -- real growth versus nominal growth (Japan has a low and sometimes negative rate of inflation) and GDP growth versus per capita GDP growth (Japan has a low-to-negative population growth trend).
Of course, real GDP growth (absolute rather than per-capita) does affect valuations of financial markets and real estate, since those valuations rely on the size of future earnings streams. Japan's asset markets have famously failed to "recover." To the extent that other nations follow in Japan's demographic footsteps, there will be some downside surprises in asset market returns in the medium to long term for many advanced nations...
UPDATE (same day):
To supplement the year-on-year growth chart above, here is a graph of the actual levels of per capita real GDP indexed for Japan and the US. Japan's surging growth in the late 1980s that accompanied its stock market and real estate bubbles did put it above the US trend, but the levels converge again before year 2000.
UPDATE 5/23/2011: After reading a post by Bill Mitchell today that appeared to contradict the findings in this post, I initially wondered whether I had erred by using the FRED2 data for Japan in which the real per capita GDP data is converted to 2009 US dollars at purchasing power parity. (i.e., perhaps this incorporated exchange rate effects as well.) However, today I extracted the appropriate source data from Japan's cabinet office and generated my own graph using yen-denominated values, and the trend line is identical to the FRED2 data I used. In other words, the trend lines for per capita GDP growth for the US as measured in dollars and Japan as measured in yen still are remarkably consistent with each other, just as this post initially showed. The main divergences in the two trends are in the time periods of roughly 1987-1990 and 1997-2000.
It turns out (based on my own graphs from the source data) that Bill seems to have accidentally switched the labels on the two lines in his second graph, so his nominal and real GDP per capita lines for Japan are reversed.
While I've been guilty of parroting some myths on Japan myself in years past, it has been enlightening to put more effort into reviewing the data for myself. Here is a graph I have been meaning to post for quite a while:
Annual Growth of Real GDP Per Capita in the US and Japan (1980-2009)
The blue line is for Japan, the red line for the US. It is quite astonishing how close in both magnitude and direction US and Japanese growth have been, when adjusted for population changes! The main divergences are Japan's burst of higher growth in the late 1980s, and its austerity-driven recession in the late 1990s. Once you adjust real GDP growth for changes in population, what you are left with is largely productivity growth. There are other factors that affect the level of GDP (and important things like employment!) but they have less effect on year-on-year growth rates once the adjustment has occurred.
Japan's famous deleveraging primarily meant a higher savings rate than before the deleveraging (corporate rather than household, in Japan's case), with the main effect being a one time shift downward in GDP level (but not growth). After the GDP shift caused by a savings rate shift, future and ongoing GDP growth is impacted by other factors such as whether aggregate demand is sufficient to bring growth back near potential growth, but Japan may have been a success story in this area! However, its success in achieving this real per-capita GDP growth may have been more a result of the falling household savings rate over the last couple decades than of government fiscal (or monetary!) policy.
Japan's stagnation myths (some people blame too much government spending, others too little!) derive in part from two sources of confusion -- real growth versus nominal growth (Japan has a low and sometimes negative rate of inflation) and GDP growth versus per capita GDP growth (Japan has a low-to-negative population growth trend).
Of course, real GDP growth (absolute rather than per-capita) does affect valuations of financial markets and real estate, since those valuations rely on the size of future earnings streams. Japan's asset markets have famously failed to "recover." To the extent that other nations follow in Japan's demographic footsteps, there will be some downside surprises in asset market returns in the medium to long term for many advanced nations...
UPDATE (same day):
To supplement the year-on-year growth chart above, here is a graph of the actual levels of per capita real GDP indexed for Japan and the US. Japan's surging growth in the late 1980s that accompanied its stock market and real estate bubbles did put it above the US trend, but the levels converge again before year 2000.
UPDATE 5/23/2011: After reading a post by Bill Mitchell today that appeared to contradict the findings in this post, I initially wondered whether I had erred by using the FRED2 data for Japan in which the real per capita GDP data is converted to 2009 US dollars at purchasing power parity. (i.e., perhaps this incorporated exchange rate effects as well.) However, today I extracted the appropriate source data from Japan's cabinet office and generated my own graph using yen-denominated values, and the trend line is identical to the FRED2 data I used. In other words, the trend lines for per capita GDP growth for the US as measured in dollars and Japan as measured in yen still are remarkably consistent with each other, just as this post initially showed. The main divergences in the two trends are in the time periods of roughly 1987-1990 and 1997-2000.
It turns out (based on my own graphs from the source data) that Bill seems to have accidentally switched the labels on the two lines in his second graph, so his nominal and real GDP per capita lines for Japan are reversed.
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