Components of GDP





I was curious about any observable trends in the components of GDP so I grabbed some data from FRED.  I used real, billions of chained 2009 dollars, quarterly, SA data for all four sets, to be consistent.  The titles of the series are at the end of the post.

 

 



It appears consumption is on the rise, as well as investment, at least as a percentages of real GDP.  Surprisingly, government spending is actually decreasing as a percentage of real GDP.  The popular opinion seems to view it the other way around.

This data and another paper got me thinking about the marginal efficiency of capital, what levels of C, I, G, and NX we need to reach potential output, and how potential output is calculated.

If the marginal efficiency of capital (MEC) is defined as the expected rate of return over costs (Skidelsky, The Relevance of Keynes, 2011) then in order for investment to occur, MEC>return from the prevailing market rate of interest. 

It appears MEC>return from market rate because investment is increasing as a percentage of GDP.

However, just because I is increasing does not mean the rate of growth of Investment is as high as we need it to be to be a full employment.  This means we could lower the market rate of interest (can't) or stimulate consumption (with perhaps redistributive policies since the market rate of interest can't be adjusted) or have the government spend money (which by historical standards if I have the graph right, isn't that crazy of an idea).

Much of the "action" rests on the idea of potential output.  Because if we are below potential, we can take action to reach potential.  So what's the magic formula for potential output? 

Further questions to explore: potential output => full employment? full employment changes with actual output? full employment = unemployment of 25%, is that ok?

Data series from FRED:

Real Personal Consumption Expenditures (PCECC96), Billions of Chained 2009 Dollars, Quarterly, Seasonally Adjusted Annual Rate

Real Gross Private Domestic Investment, 3 decimal (GPDIC96), Billions of Chained 2009 Dollars, Quarterly, Seasonally Adjusted Annual Rate

Real Government Consumption Expenditures & Gross Investment (GCEC1), Billions of Chained 2009 Dollars, Quarterly, Seasonally Adjusted Annual Rate

Real Gross Domestic Product (GDPC1), Billions of Chained 2009 Dollars, Quarterly, Seasonally Adjusted Annual Rate

My grandma was a physicist

Casey Mulligan argues in his new book, “The Redistribution Recession” that redistributive policies cause distortions in the labor market and contribute to the weak gains in employment during the recovery.  In other words, redistributive policies the increase the opportunity cost to being employed.

 

 

First, let's accept his assumption that citizens are rational decision makers and accept his claim that redistributive policies encourage people to stay unemployed. It appears his argument still overlooks the effects of unemployment on employment.  Rational, calculating decision makers that have access to the same information as everyone else should be considering the effects of unemployment on long-term employability.  Unemployment can dry up networks and deteriorate both soft and hard skills.  Knowing government aid is not indefinite, it seems long-term employability might become a factor when deciding how hard to search for a job. Larry Ball has examined high unemployment and found that high unemployment causes higher levels of unemployment in the future- the phenomenon of hysteresis, "There is more evidence for stories in which the long-term unemployed become detached from the labor market. These workers are unattractive to employers, or they don't try hard to find jobs" (Ball, 2009). While it may be hard to measure "the degree to which one engages in job searching" it isn't difficult to figure out how may jobs are available to the number of applicants.

 

Second, another underlying assumption Mulligan makes (I haven't read the book, so I'm not sure if it is implicit or explicit) is that employers need workers.  If employers didn't need workers, then it isn't sensible to say people lack proper incentives to work.  For example, if there were 100 applicants for every 1 job opening, and the government distributed generous aid packages, could we claim the generous aid packages led 99 workers to be less rigorous in their job search?

 

Third, speaking to the title of the book, redistribution can definitely be observed, although not in the direction one might think. Emmanuel Saez’s work demonstrates the income redistribution during the recovery from the recession was in fact upward, “However, the gains were very uneven. Top 1% incomes grew by 31.4% while bottom 99% incomes grew only by 0.4% from 2009 to 2012. Hence, the top 1% captured 95% of the income gains in the first three years of the recovery” (Saez 2013).

Fourth, if companies need workers and the opportunity cost to having a job is high, why can't wages be the adjustment? Raising wages would increase the incentive to work and decrease the opportunity cost to having a job. 

Fifth, I’ve thought about how Mulligan's argument can be seen in terms of historical debates.  Take Kalecki’s “Political Aspects of Full Employment” for example.  In the most general sense, placing  Mulligan’s argument within Kalecki’s narrative is relatively simple.  Expanding redistributive policies during a time when employers don’t wish to invest expands the government’s role diminishing the importance of business confidence. 

Furthermore, a specific type of expansionary policy “subsidies for mass consumption” is even worse than possibly crowding out the business sector because workers must WORK for their livelihood. 

 

                “One might therefore expect business leaders and their experts to be more in favour

of subsidizing mass consumption (by means of family allowances, subsidies to keep

down the prices of necessities, etc.) than of public investment; for by subsidizing

consumption the government would not be embarking on any sort of ‘enterprise’.

In practice, however, this is not the case. Indeed, subsidizing mass consumption is

much more violently opposed by these ‘experts’ than public investment. For here

a ‘moral’ principle of the highest importance is at stake. The fundamentals of capitalist

ethics require that ‘You shall earn your bread in sweat’—unless you happen

to have private means.”

 

Sixth, if we acknowledge people have more than one dimension (as a worker) and are embedded in  families and communities (as Polanyi, Marx, or Veblen might observe) we might find unemployment causes psychological stress both internally and externally.  Jobs may be fulfilling and not having a job may be stigmatizing. 

Ball, L. (2009). Hysteresis in Unemployment: Old and New Evidence NBER Worker Paper No. 141818.

 

Kalecki, M. (1943). The Political Aspects of Full Employment.

Saez, E. (2013). Striking it Richer: The Evolution of Top Incomes in the United States (Updated with 2012 Preliminary Estimates). http://elsa.berkeley.edu/~saez/saez-UStopincomes-2012.pdf

No one ever got fired for using an HP filter!

(The title of this post is one of my professor's famous sayings) 

I was investigating the deviation of real GDP is from its HP trend, expecting it to be negative from 2008 until now. I found real GDP has actually been above trend since about 2012. If I managed to get the HP filter to work correctly (as we all know how easy it is to make excel errors),  a couple graphs may help demonstrate how trends can be misleading:

 

This first graph shows a vague but nice picture.  No crazy spikes or downturns.  Of course, time series data tend to smooth things out.  Additionally, the trend tends to smooth out the small number of kinks that do exist.

The next graph is the same series, just chopped off at the 2007-2013 range.  Here, it appears the 2008 financial crash was just a deviation from the trend and about 2012 is when real GDP started operating above trend. 

 

The graph above looks like a positive picture.  But, we have to keep in mind the trend was based off of all of the data, 1947 until the present. This means the trend was able to capture the dip in real GDP and adjust accordingly to make real GDP a little bit below trend sometimes and a little bit above trend sometimes. In other words, if we summed up all the deviations from the trend, we'd get zero. 

 

I don't know too much about the theory of real business cycles but when I do hear about it, I always hear it in the context of "output fluctuating around a long-term trend". But in this case, being above the trend doesn't mean the economy is doing well or we are in a time of expansion, it just means in order for the deviations to equal zero, the deviation from trend must be positive now.

Implications for Student Debt on Growth

A recent  Krugman post got me thinking about secular stagnation and reasons why demand might not be as strong in the future, 

"Instead, the argument is that the sources of demand during the good years – the Great           Moderation from 1985-2007 – are not going to be available even when the after effects of crisis have faded away." -Krugman
 
As a past and prospective student, my spending is curbed by my student loans. I chose to forgo future consumption for present consumption. I am not in the minority either.  Low interest rates on loans are not attractive to me.  Borrowing several thousand dollars to put down on a house is not desired and probably not even a reality.

As a Millennial, I realize my generation is noted for starting life a little late.  The Great Recession bumped some of us back in with our parents and significantly delayed our life plans.  Life plans which might include borrowing money to purchase a car, a home, or to start up a business.

The point is what Krugman is trying to contemplate; this magnitude of student debt was not a feature for most of the Great Moderation.  People were able to take out loans for houses, cars, start-ups because they didn't have 20k in debt already.

This leads to some interesting questions-

Could student debt reach the household levels of debt (during the Great Moderation) to boost us out of this stagnation?

Once this loan burdened generation pays off their debt, will the stagnation be over? The "putting off" of life plans would come to an end and we could see a spike in borrowing and spending.

Does student debt prevent successful entrepreneurial activity from happening? If so, what are the implications to investment?

My Bubble Brings all the Boys to the Yard

I think Axel Leijonhufvud is one of my new favorite economists as one of his papers is titled, "Bubble, bubble, toil and trouble".

Besides the name, it seems in my humble opinion, Leijonhufvud has always got interesting things to say.  In the article mentioned above, he states the Fed's mandate is not financial stability, but price stability, i.e. inflation targeting.  Financial stability is largely regulated to policy which has been bi-partisanly thrown out the window. 

After the financial crisis reminded us how (Marx)/Minksy's financial instability hypothesis worked, suddenly regulation and macroprudential policy were the new topics of the town. 

However, the new, new topic of the town is secular stagnation and if we believe we are in this situation- where as Krugman would say "prudence is folly"- then where does macroprudential policy fit in, if anywhere?

The Keynesian brand "any spending is good spending" in a Lerner "topsy turvy" world seems to make sense.  But somehow letting banks run wild, setting up the dominos on a tight rope again doesn't seem to make as much sense. 

Although there doesn't appear to be a significant bubble like the housing bubble that contributed to the financial crisis, what's to say that this time is different? 

Making Sense of Secular Stagnation via J.M.Keynes and Joan Robinson

If secular stagnation is defined as and implicates "a systematic tendency for aggregate demand to fall short of the economy's potential output" (Mason, The Slack Wire). We can encourage spending by:

1. Even lower/negative interest rates and/or embracing bubbles (increasing consumption and investment)

2. by consistent government investment (increased, stable investment)

3. by socializing investment (stabilizing investment)

4. by redistributing excess savings of the rich to the heavy consuming poor or by redistributing the excess savings into productive investments.

I don't think any of these options are particularly easy to accept or even think about, but the one most discussed by Krugman and Summers is the idea of negative interest rates and the functionality of bubbles.

I'm hesitant to jump on board with the bubbles are useful train. It is easy to see how an economy benefits from bubbles during their climb to the top, but the bursting of the bubble might cause more damage than good. If the people who are investing in these bubbles are rich and are just looking for a place to put their money, it may not be harmful if the bubble pops and they don't get their return back.  However, the most recent housing bubble showed us just how devastating bubbles can be; the disruption of financial intermediation almost brought down the financial system.  Perhaps this was a special case of a bubble causing more damage than it normally should, however, I think we should consider the costs and benefits.

Negative interest rates may not sit well ideological with people trained to save now for more later.  And if we are seriously considering using bubbles as tools and punishing people for saving money/not investing why don't we examine other, perhaps more reasonable options?

Keynes and Robinson have some ideas.

"I conceive, therefore, that a somewhat comprehensive socialization of investment will prove the only means of securing an approximation to full employment; though this need not exclude all manner of compromises and of devices by which public authority will cooperate with private initiative.                              
                                   -(Keynes, The General Theory of Employment, Interest, and Money)

What he's arguing for here is for a change in the way investment in the economy is carried out.
Letting managers run businesses not for their shareholders, but for the sake of running a good business.  If the people running a business are invested in it and are not constrained by shareholders, perhaps investment would not be so volatile and profit would not always be the driving motive to invest.

Robinson appears to be calling for something a little more radical. My macro professor's favorite essay gives us a glimpse of what she was outlining:

"There are a number of spheres of activity in which operation through public corporations, on a non-profit basis, can be justified on its own merits, quite apart from the employment problem. If these were taken out of the hands of private enterprise, long vistas of useful investment would be opened up. A national medical service, such as Sir William Beveridge foreshadows, would require a large volume of investment, not only in the bricks and mortar of health centres and sanatoria but in training medical and nursing staff on a scheme of State bursaries. House-building is conceded, at least in part, by the industrialists to be a proper sphere for public investment, and this opens up a huge field. Public operation of transport opens another, fuel and power a third."

                                                                                      -(Joan Robinson, Letter to the Times, 1943)

So instead of government investment being crammed into spheres that can quickly become unproductive (i.e. building roads), Robinson argues productive investments should be undertaken by the government (i.e. healthcare, transport, and fuel).  An opponent of this view might observe  private investments would be crowded out.  But then Robinson reminds us why we are thinking about government investment in the first place,

"Even if there were no objection on general grounds to subsidizing private investments, it would be an extremely weak defence against the onset of a slump. For the characteristic of a slump is the disappearance of prospective profits, and no practicable reduction in the cost of borrowing can induce firms to embark upon capital expansion when the prospects of profit are nil"

                                                                   -(Joan Robinson, Letter to the Times, 1943)

Private investments are made when there is a prospect of profit, without it, why would an investor invest?  The government however, is not constrained by the profit seeking motive.  If they would pay people to dig holes or pave roads to nowhere, why not invest in healthcare or utilities instead?

The last option, redistributing the excess savings from rich to the poor, would be a good economic idea if you believe the poor have a larger propensity to consume. This is sort of a Kaleckian solution.  However, thus far, redistributive policies have not been very effective, at least recently.  Income inequality is at its greatest heights since the Great Depression. Documentaries like We Are Not Broke reveal the effort and the extent enterprises go to not pay taxes. Minimum wage increases and unions are treated like the plague by most of the private sector.

In a world of low interest rates it seems people would want to spend and not save.  However, five years of extremely low interest rates have not provided the impetus of consumption nor investment to get the economy back to full employment.  As Keynes suggests in Economic Possibilities for Our Grandchildren, perhaps consumption has stagnated because people have enough stuff. Or more practically, people are too leveraged already. This situation is easy to imagine as a student with massive loans to pay off.  If people are not consuming, there must be money available to invest, so why has there not been an investment boom.  I think there are two responses to this:

1. Investment  depends on the rate of profit and as more savings accumulates to be used for investment, the profit rate falls, as investment opportunities yield less and less returns.  Thus the argument from both Keynes and Robinson to alter the nature of investment. Without investment, incomes fall, pushing savings down to the level where it equals investment.

2. The Washington Consensus forced open a world where capital can fly freely.  If investment opportunities dry up at home, there are other opportunities abroad the savings can go.

However, this brings us to a few odd things about secular stagnation.  In reality, capital flows from rich countries to poor countries, indicating countries like the US have trade deficits.  A trade deficit means we are importing more than we export, so it appears we are in fact consuming, just not domestically.  Could capital controls shift consumer demand for imports to domestic goods and help us out of the stagnation? Keynes argued for the benefits of capital controls in National Self-Sufficiency.

In The General Theory of Employment, Interest, and Money, Keynes describes the "euthanasia of the rentier", in Economic Possibilities for Our Grandchildren, he discusses working 15 hour weeks.  Keynes' version of secular stagnation doesn't quite add up to the reality in which we live in today.  People continue reap extravagant interest payments and we certainly don't work 15 hour weeks.

Even if Keynes' vision didn't completely come to be, his and Robinson's ideas of overcoming investment's fickle nature call for serious consideration.  If secular stagnation is the future, we need to examine each tool critically and carefully.

As an aside- If we are in fact in a world where aggregate demand consistently falls short of potential output, austerity seems completely ridiculous   If we are living in "topsy turvy" economy as Abba Lerner might call it, where any spending is good spending, let's not cut food stamps.