Friday, January 28, 2011

Great News! Fourth Quarter Money Expenditures Increase Sharply! Inflation Stays Low!

The estimate for Final Sales of Domestic Product for the fourth quarter of 2010 was $14,865 billion.   This was a 7 percent increase from the third quarter.    Since the sharp decrease in the 4th quarter of 2008, this is the first increase that was greater than the 5 percent trend of the Great Moderation.   In fact, it was the first increase that wasn't less than 3 percent.

If money expenditures had continued on its trend growth path from 1984 to the end of 2007, it would currently be $17,013 billion.    The current value remains 12.43 percent below trend.   However, this is the first quarter since second quarter 2007 that the gap from trend actually decreased  Unfortunately, for it to return to trend by the fourth quarter of 2011, it would need to grow 20 percent from the fourth quarter of 2010.    While 7 percent growth seems quite fast, at that rate, it would take nearly a decade for money expenditures to return to trend.

The chart below shows the trend of the Great Moderation in red and actual money expenditures in blue.   The dashed line is the 20 percent growth necessary to return to trend in one year.

I favor adjusting the target for money expenditures to a three percent growth path starting at the beginning of the recession at the end of 2007.    This would allow for a substantial recovery of money expenditures, while moving to a new growth path consistent price level stability in the long run (at least if the productive capacity of the economy returns to growing 3 percent.)    The target for the adjusted growth path is now $15,809 billion.   The current value of Final Sales of Domestic Product is 6 percent below that target.    In order to return to target within a year, it would need to grow 9.6 percent. (from fourth quarter 2010 to fourth quarter 2011.)   If the current 7 percent growth rate continued, it would reach the adjusted trend by the second quarter of 2012.    Then, to stay on the growth path, the growth rate would need to slow to 3 percent.

The chart below shows the adjusted growth path in red.   The first portion shows the 5 percent growth rate of the Great Moderation and then slows to 3 percent in the fourth quarter of 2007.   Final Sales of Domestic Product is shown in blue.   The dashed line shows the 9.6 percent growth that would be needed to return money expenditures to target.

The other good news is that inflation, as measured by the GDP chain-type price index, showed an inflation rate of less than 1/3 of a percent.    Growing expenditures on output and slow increases in prices should result in rapid increases in real output.   While the real GDP figures showed much slower growth, this means that inventories were being depleted.    In my view, getting the amount that firms can sell (in aggregate) to a predictable growth path is the goal, and that should result in fewer surprises, where sales outstrip production or vice versa.

The low inflation rate implies that the price level is even further below its 2 percent growth path from the Great Moderation.    The current gap is 2.75 percent.    In my view, 2 percent inflation is 2 percent too high, which is why I favor a shift from a 5 percent to a 3 percent growth path for money expenditures.   While there is reason to believe that 9 percent growth of money expenditures over the next year, or 7 percent over the next 18 months, would raise inflation somewhat, the long run goal should be a stable trend for the price level.   Last quarter's estimate is a good start.


  1. Bill
    Hi! Remember me? To let you know that I put up an "extended comment" on David´s latest post where you also "come into play".
    Have a nice week-end.

  2. SIncerly, I don´t understand why is so important for you NominalFSDP if 2% inflation is too much.
    I can understand if you think (as I do) that some inflation is important. Would not be more simple to fix Real FSDP?
    I tend to think some inflation is important because prices and wages adjust very slowly. I suppose that is the reason for Central Banks to pursuit a low but positive inflation rate.

  3. I don't think a target of 3% is advisable without pursuing policies that enhance labor market flexibility. I prefer 5%.

    However, in real terms the increase in FSDP was 7.1%, the most in 26 years. I think this shows a number of things:

    1) QE2 worked
    2) Expectations matter (Bernanke’s Jackson Hole speech probably did more than the actual implementation)
    3) There are no lags to monetary policy.

    Needless to say an explicit target would help much more than an arbitrary asset purchase figure. But first more people need to be convinced that 1) printing money has real effects in the short run, and that 2) something needs to be done.

  4. I don't believe that we can expect that a permanent, planned depreciation of money by some rate can occur without workers expecting an equivalent raise.

    Sure a noninflationary growth path of money expenditures means that the trend rate of pay increase is only 3%. If a shift in demand for particular type labor requires a more than 3% increase in real wages, simply holding the line of those workers wages for a year will not bring them into to equilibrium.

    But would 5% or 10% money expenditures growth really help? How much inertia will there be in the implied 5% or 10% growth in money wages? How fast does inflation have to rise, year and year at a constant rate before people expect "cost of living" raises?

    Further, when people do expect such raises, what happens when there is an adverse shock to aggregate supply? A situation where "cost of living" raises are inappropriate?

    Still further, how often should people take a sectoral 3% real wage cuts (and someone else is getting increases) and not have career shifts?

    I don't buy this "inflation lubricates relative real wage adjustments."

  5. I don’t really like inflation at all, I always try to plan with keeping things simple, but I do prepare for anything surprising. I am lucky enough to work with OctaFX broker, as they have great 50% bonus on deposit, it helps me big time given I am able to create really solid money management that helps me work smoothly and leads into good profits consistently, so that’s why I don’t take much tension about anything at all in any situation.