I swiped another graph from the great economist and author of Market Monetarism: Roadmap to Prosperity, Marcus Nunes, today and it sums up the current economic problem quite nicely. The US economy seems to be “missing” a very large nominal sum of approximately three trillion dollars in output. That is, of course, the difference between the 1987-97 NGDP trend and actual NGDP at the end of 2012.


Taking a look at the graph thinking about the mandates spelled out in the Full Employment and Balanced Growth Act of 1978, it’s seems very difficult to support any theory about the Great Recession that doesn’t include the Federal Reserve as a major culprit in the caper (and yes, I mean “caper” as is in “questionable activity: a dangerous and illegal act”).

Here’s the text of the mandates again:

[The Federal Reserve] shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.

If the Fed had been minding its legal mandates, we would not be missing three trillion dollars in output five years after the big “crash”. But there’s more to it than just trying to explain it away by assuming that the missing output could be caused by the severity of the recession. The actual NGDP line shows that something was going wrong well before the summer of 2008.

That part is perhaps something we might be able to overlook as an honest mistake in the midst of a recession that had been impacting the financial sector quite dramatically; and hind-sight is always 20/20. I find it hard to understand why the downward movement isn’t arrested well before it finally flat-lines. Surely 18 months of data should have been enough for the Fed to figure out just how far off track it had become by the end of 2009, if not before.

Some say that debt is the problem. We just had too much of it. Actually, I think it is more like a symptom rather than a cause; because if we end up missing $3 trillion, it will be very difficult to maintain debt that was issued without knowing the Fed would allow nominal output to be flushed down the vortex of the giant crapper from hell. If you knew you would be making less in 6-7 years, you would not be contracting more debt than you thought you’d be able to afford. And no one knew the Fed would allow debt loads to become so much less affordable – it just did it.

This is the key to understanding the origins of the economic crisis and how expensive the concept of “central bank independence” has been – because it impacts all spending and debt, including government debt. And the Federal Government is the largest spender and debtor on the planet.

Contrary to what my conservative friends say about government debt being the largest single problem in the economy, it probably isn’t. Rather, the single largest problem in the economy is an independent Federal Reserve that gets to pick and choose what it will or will not do, and when. It is the cause of the debt load being too large to bear by willfully failing to maintain nominal output or correct the trajectory when a problem was apparent.

I sometimes wonder what the heck these Fed guys are talking about when they discuss the “costs and risks” of QE. Surely, their cost benefit analysis is flawed. It has to be flawed in not considering the huge opportunity, social and political instability costs involved in suddenly “missing” $3 trillion dollars from the economy.

For those who are very active in politics, I have to say that pounding on the politicians to do something about spending and debt is probably not an effective use of time. Instead, the politicians should be hounded to figure out what to do with officials at the Federal Reserve when they wander off the Full Employment and Balanced Growth Act reservation and refuse to wander back.

PS: The calculation I included as a postscript to my purpose statement is one that tells how long the Fed will take to “catch up” to trend inflation at its stated objectives of 6.5% unemployment or inflation < 2.5% if it is serious that the 2% target is a long run target (~17 years). It seems to me that it is at least a decade too long to be consistent with the mandates. The Fed is still dragging its feet and so I do not expect QE3 to work all that well (better than nothing? maybe). It needs to do much more if it chooses to maintain an inflation or price level target because it would need to run ~3.4% for six years to catch up all that it is behind since 2008 in order to hit the long run of 2%.


The thought occurred to me that perhaps in officially stating a 2% target in early 2012, the intent of the message was to forget about everything it had done in 2007-10 – effectively disavowing itself of any make up or repairing the damage it wrought dabbling with an all inclusive, headline inflation targeting regime – as in from here forward 2% is the target.

I am very glad they weren’t allowed to get away with it, but many who are satisfied with the response I think miss the point that it is still dealing with inflation targets; and so in those terms, the new face of the Fed is not much different than the old one @ ~17 years to make up for all that has been lost.

[Another, minor update]

The “missing” $3 trillion is a simple figure. It accounts only for 2012 – where we should have been if NGDP had been maintained on trend. I haven’t sat down and calculated the actual shortage, but it’s probably somewhere in the area of min. ~$12 trillion compounded yoy since 2009. That is one heck of a lot of productivity tossed in the circular file in the name of… um… what, again? Oh yeah, letting Nigerian Rebels control US monetary policy. Even at 3.4% or even 5% inflation, it’s still a lot of AD, nominal income, output – however one wants to label NGDP. And if we think it doesn’t have any “real” effect… we’re seriously insane.