Episode #13 – Recession, Hyperinflation, and Stagflation

It’s been a while, I know.  I’m still about 4 episodes behind, but I’m about to start publishing my posts on a fixed schedule to catch up, and so you know when to expect them.  Stay tuned for more info in the next post.


As per usual, this episode of Crash Course was a mixed bag of good, bad, and glossed-over economics.  I’m going to start with the most egregious mistake:

Military Spending

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Getting out of the depression took nearly a decade, and it wasn’t really monetary policy that put an end to it.  It was the massive government spending of World War II.

But Adriene!  Remember what you said in Episode 1?:

Military spending in the United States is over $600 billion per year.  That’s close to what the next top 10 countries spend combined…the opportunity cost of [each] aircraft carrier could be hospitals, schools, and roads.

I realize now that Crash Course believes any and all government spending is good for the economy, including things that do not benefit the public generally.  If you remember back to their discussion of opportunity cost in week one, every dollar spent (either by government or private persons) could be spent somewhere else (also either by government or private persons).  So why would Crash Course think that military spending can help get the government out of depressions?

In short: Keynesianism.  We talked about the show’s Keynesian Presuppositions before, but this makes it clear: Crash Course believes spending is what fuels the economy.  When people are not spending, governments need to step in and (tax and) spend for them!  If you recall, we critiqued this idea in episode 5, so I won’t go through it again, but in short: saving also fuels the economy.

Monetary Balance

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An increase in the money supply can have two effects.  It can increase output or increase prices or some combination of the two.  Inflation starts when output is pushed to capacity and can’t rise much further, but policymakers continue to increase the money supply.  In theory, once output is maximized, the more money you print, them more inflation you’ll get.

This theory, stated as fact here in Crash Course, is one of multiple ideas of how the money supply affects the economy.

First, the “output or price” dichotomy is generally not how most economists think of money printing.  All economic schools of thought believe that money printing will always increase prices, but some economists think that the boost to output is worth the pain of rising prices.  It’s not an either/or scenario; it’s an “is it worth it” scenario.  Sometimes the price inflation doesn’t occur immediately, but as the money circulates, prices will rise.

The Austrian School however, argues that money printing will distort the economy, flooding money into certain areas and creating bubbles, only to eventually crash and do even more harm than if the government had not interfered at all.

Hyperinflation

Crash Course rightly puts some of the blame for hyperinflation on central banks who print money to oblivion, but they also seem to blame consumers:

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After a couple of years of doubling prices, people started to expect high inflation, and that changed their behavior.  Say you’re planning to buy a new refrigerator, and you expect prices to rise quickly.  You buy it as soon as possible before the prices have a chance to change, but with everyone following that logic, dollars start to circulate faster and faster and faster.

Economists call the number of times a dollar is spent per year the velocity of money.  When people spend their money as quickly as they get it, that increases velocity, which pushes inflation up even faster.

Consumers do not create inflation (central banks do), but they can speed up or slow down how long it takes for the newly printed money to affect prices.  If the central bank printed a bunch of money but kept it out of circulation, prices would not rise, but when that money starts to circulate, then prices rise.  Once the new money is out there, it can take a long time or a short time for that to affect prices, but the eventual rise in prices is due to the initial money printing.

But Crash Course seems to think that consumers’ eagerness to spend is what pushes prices up, even if the printing has stopped.

Let’s imagine an economy without a central bank setting interest rates, and instead, interest rates were determined by the market.  If something like this were to happen and everyone quickly spent their money as soon as they received it, businesses who wanted large loans would have a very hard time getting them, since money is being spent instead of saved.  The most in need of loans would be willing to pay a premium for it, and banks would offer high interest rates to encourage people to save money, so they could lend it out to businesses.  People would eventually stop spending as much as they notice that it would be more beneficial to save their money and collect a high interest rate.

Once a central bank enters the picture, interest rates are held artificially below the market rate, encouraging people not to save and for banks to borrow more newly-printed money from the central bank for a low rate.

Later in the video, Crash Course uses the same logic to talk about rapid deflation: consumers’ expectation of lower future prices keeps them from spending and sends prices further down.  It’s a much harder argument to make for them, and we’ve already covered this argument in this post.

Stagflation

Crash Course correctly identifies what Stagflation is: when the economy is not improving but prices rise quickly.  But when they explain the United States stagflation, they miss a key point:

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The US experience Stagflation starting in the 1970’s after a series of supply shocks, including a rise in oil prices, and believe it or not, a die up of Peruvian anchovies, which were important for animal feed and fertilizer.

I’ll pick the “not” option.  Natural disasters and supply shocks can have negative (or stagnant) effects on the economy, but these do not cause the inflation part of the stagflation formula.  What does this have to do with central bank money printing?

It was very surprising to hear an entire section on Stagflation without mention of the Bretton-Woods System and the United States’ complete removal from the gold standard.  That’s almost like talking about the 2008 financial crisis without mentioning FEHA or Fannie Mae.

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Bretton-Woods was a monetary system that the United States had from 1944 to 1971.  It was a quasi-gold standard, where the government still fixed the price of US dollars to gold.  The Bretton-Woods System also establish the US Dollar as a reserve currency, and allowed foreign countries to trade their US dollars for gold at the fixed rate.

Throughout the 1960’s, US money printing made many international countries nervous about the dollar’s viability, and many of them exchanged their US dollars for gold.  Eventually, the United States ended its international dollar/gold exchange, thus ending the Bretton Woods system and creating free floating fiat currencies across the globe.

Naturally, the end of the Bretton Woods system caused the US dollar to plummet in value relative to foreign currencies.  It became very expensive to import items and for US companies to do business internationally.  The resulting strain on international trade caused prices to soar in the United States.

 

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Crash Course Episode #10, Monetary Policy and the Federal Reserve

This topic had to come up in a course about economics: Monetary Policy and the Federal Reserve.  This episode was mostly informative and less opinionated than other episodes, but there were still some major problems that need clarification:

“Decreasing the Money Supply”

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Crash Course mentioned that the Fed can increase the money supply through different means in an expansionary policy, but they also said many times that in a contractionary policy, the Fed can decrease the money supply.  They even mentioned as an example that in the 1970’s, Fed Chair Paul Volcker decreased the money supply to combat inflation.

A decrease in the money supply would mean that the Fed is literally taking money out circulation and eliminating it, so there are fewer dollars circulating in the economy.  This never happens.

What does happen (and what Paul Volcker did) was increase the discount rate so that money was being created at a much slower rate.  Since the Fed creates money and lends it to commercial banks at the discount rate, increasing the discount rate would mean that fewer loans are made to banks, so less money is being created.

So the Money Supply never decreases, it just slows the rate of increase.  These are two very different things, as important as the difference between the deficit and the debt.

The Great Depression

Crash Course often says that answers to certain economic questions are very complicated, but they don’t seem to have a problem with claiming what prolonged the great depression:

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The Fed gets blamed for prolonging the Depression because it didn’t give banks emergency loans, which would have increased the liquidity in banks and the money supply in general.

This is a very big statement about the Great Depression, essentially arguing that the Depression would not have been as bad if the Fed had just bailed out the banks.

This is a highly debatable suggestion to say the least, as economists and historians still disagree about what made the Great Depression so severe, compared to previous slumps.  It is very likely a combination of monetary and fiscal policy, and The Austrian School would even suggest that the Fed’s very expansionary policy throughout the 1920’s caused the Great Depression’s severity.

Additionally, since the United States did bail out banks following the 2008 financial crisis, why was the recession so prolonged?

Why Has There Not Been Any Inflation?

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If the Fed has been increasing the money supply steadily since 2008, why has the actual inflation rate stayed so low?

Crash Course gives three possible answers to this: 1. Banks are not lending out the money they receive from the Fed, so the dollars are not circulating to increase prices.  2.  Uncertainty in Europe, which means foreign investors are holding US Dollars, so again, they are not circulating and raising prices.  3.  The economy is still sputtering.

For number 3, why would low inflation be the result of a bad economy?  I suppose that Crash Course is saying that too many people are saving instead of spending, so money is not circulating in the economy and pushing prices up.  This brings us back to our discussion on Deflation, Saving, and Spending, which I won’t rewrite here.

An alternative explanation that Crash Course did not mentioned is that prices are rising quickly in certain sectors of the economy, namely housing (again) and high-priced luxury goods.  If the newly-printed money is only being used in these areas, it will take longer before the prices of normal consumer goods rise.

 

As I mentioned at the beginning, a lot of this episode was an explanation of what the Fed does, since it’s probably not common knowledge for the normal Crash Course fan.  Besides these few (albeit major, especially the first one on decreasing the money supply) errors or opinions, the episode on the whole was pretty informative, and it did a good job at explaning a very difficult concept quite clearly.

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Crash Course Episode #9, Deficits and Debt, Part 1

In this week’s episode of Crash Course Economics, the hosts talk about deficits and debt.  This episode might have better scheduled if it were before the videos on Keynesian Macroeconomic Policy, where they talked about deficits and debt, only to define the terms later.

Debt and Spending

Crash Course opens the episode by defining the terms debt and deficit, and explaining how the United States has the largest debt of any country, but the US debt as a percentage of GDP is not as high as a few other countries whose economies are doing fine, namely Japan.  However, the major concern isn’t the current size of the debt, but the growing deficit.

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Most economists are not worried about the borrowing that the US has done already, because they are too worries about the borrowing they’re going to do.

This is true, and as shown in the graph above, the US deficit is scheduled to increase through in future decades as government spending increases.

In the “too much spending vs. not enough revenue” argument, Crash Course shows that revenue (i.e. taxes, fees, tariffs, etc.) is set to increase (as a percentage of GDP) in the coming decades, so this is “not the problem”.  While this is a subjective political argument (socialists and progressives might say that taxes are not high enough), we’ll assume that what she meant was that the increasing deficit is caused by increasing government spending, not decreasing revenue.

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To de-politicize the spending issue, our co-host Adriene gives her explanation of which side is right when it comes to the question of “Where is there too much spending?”:

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Let’s look at where the government actually spends its money.  Conservatives might complain “It’s obvious!  Handouts!”  Liberals will say “It’s obvious!  Defense!” Well, they’re both wrong.  So who’s the biggest recipient of federal dollars?

Grandma and Grandpa.  The government spends about a quarter of the budget on Social Security, and another quarter on healthcare programs.  A lot of that goes to retired people on Medicare.  They deserve it!  They worked hard.  And those are the programs that are expected to grow as baby boomers retire and live longer.  Defense and other discretionary programs are actually projected to shrink slightly as a percentage of GDP.

First, let’s ignore the out-of-place and opinionated commentary of “they deserve it!  They worked hard.”

Second, while retirement spending is scheduled to increase significantly, so is defense.

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The graph above shows the nominal costs of the Department of Defense.  Until about 2022, there is an increase in spending.  After that, it will stay at about 600 billion per year.

However, Adriene is right that Defense will shrink as a percentage of GDP, as you can see in the graph above.  So if we’re looking at the cause of the increase in the deficit, as opposed to the already large deficit/debt or spending in general, she is correct.

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Also, if tax-funded healthcare for the elderly is one of the leading causes of the increasing deficit, are conservatives actually wrong when they complain about “handouts”?  I understand that Crash Course tries to remain politically neutral, but if the argument is between handouts vs. defense being the cause of a rising deficit, and you explain that Medicare is a primary cause, conservatives (in this case) are not wrong.

Also, in the liberals vs. conservatives argument, rarely have I heard the argument phrased within the context of defecit as percentage of GDP.  Liberals are usually arguing that there is and has been too much defense spending generally, and conservatives argue against handouts being such a large part of the budget generally.

Debt and Borrowing

Our co-host Mr. Clifford explains how the US finances its debt:

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First, to borrow, you need lenders, people who have decided to save money and loan it out, rather than spend it on something else.  But there is a finite amount of money that savers can lend, and most of that savings is borrowed by the private sector, which is consumer that take out car loans and businesses that pay for things like factories and computers.

When the government runs a budget deficit, it borrows from that same pool of savings.  And if the government continues to borrow, many economists worry that there will be fewer loans available for businesses, and that will hurt the long-run growth of the economy.

This is a huge misrepresentation of how government fuels its debt.  Here is a graph that accurately shows who hold the government debt:

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As you can see, domestic private investors, like what Mr. Clifford was talking about, account for less than 15% of government debt.  The largest portion (34%) comes from international investors, which could be foreign governments or foreign citizens who are lending money to the US government and hoping to be paid back when the bond matures.

Federal Accounts accounts for 28%.  This is where the government essentially borrows money from itself.  Since different departments have different budgets, and some don’t necessarily need to spend it this year (for example, the budget that holds the Social Security deposits you’ve contributing to and hoping to get back eventually), other departments can borrow from those accounts and promise to pay it back later.

The Federal Reserve accounts for 14% of the debt.  This is when the government creates money with a push of a button and buys treasury bonds (which is what you get when you loan money to the government).  When the loans matures, the money is then just put into the treasury.

This is a big misrepresentation by Crash Course, and I was very surprised that they described US debt holders as only domestic lenders.  How did this script get through production without someone saying “maybe we should say that this is only about 15% of debt, and there are many other ways the US finances its debt?”

We’ll pick back up with the rest of the video in Part 2.  Stay tuned to see what Crash Course says about interest rates, and scenarios when spending might not get out of control.

 

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Crash Course Economics #7, Inflation and Bubbles

Crash Course’s episode this week deals with inflation and bubbles, and while they do a solid job on explaining how the CPI is calculated and the difference between nominal and real numbers, their explanation of the definition of inflation and causes of inflation were either misrepresented or not fully explained.  Let’s start from the top:

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What is Inflation?

The first thing I noticed about this video is that they never really define what inflation is.  Instead they start with the question “Why should we care?” and then explain how a reduction in your purchasing power limits the amount of stuff you can buy, so you should care.

This is probably the best time to note that there is a difference of opinion on what the definition of inflation is, and this debate is particularly between the Austrian School and everyone else.  The Austrian School of economics defines inflation as an increase in the money supply (often referred to as “printing money”), while price inflation is when the prices of goods rise.  Austrians get kind of nit-picky when people refer to inflation as an increase in the price of goods, as Crash Course does here, so I felt I needed to mention it.

As a personal view, I think a lot of time is wasted in debate talking about what the definition should be, so if people want to call the increase in prices inflation, I’m okay with it as long as we both use the term the same way.  The more important conversation is what causes [price] inflation, why, and is it a good thing?

After explaining how inflation is calculated, the video identifies that there are really two types of inflation:

Demand Pull Inflation

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They define this as “too much money chasing too few goods.”

Crash Course’s explains Demand Pull Inflation by saying:

If people have a lot of money, and they want to buy more stuff, they are going to bid up the prices for things, causing [demand pull] inflation.

This explanation of inflation is generally agreed upon between schools of economic thought, but it doesn’t fully explain what makes people have a lot of money.

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Sometimes, but rarely, a whole town strikes it rich (which is more or less what is depicted in the Crash Course video).  For example, some towns in North Dakota are now seeing prices rise because an oil field was discovered under the town, creating thousands of high-paying jobs.  Since more people have more money to spend, prices in the town increase.  But this rare scenario is not what most people consider to be inflation.

Inflation is generally thought of as prices increasing across the country, which means that both my local pizza shop and Amazon.com have increased their prices.  This kind of inflation is caused by an expansion in the money supply, meaning that new US currency has been printed and is circulating throughout the country, bidding up the prices of all goods.  Those who benefit most from inflation are the ones who get to touch the newly-printed money first before prices have risen (which are, generally speaking, investment banks), and those who suffer the most from inflation are those who touch the money last, as they usually get their wages increased only after prices have risen.

While Crash Course wasn’t wrong in their explanation, they did leave out the very important point of the origins of inflation, which they will hopefully cover in a future video.

Cost Push Inflation

Crash Course also includes a second type of inflation, which is referred to as Cost Push Inflation:

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Another cause of inflation is the decrease in availability of an important productive resource, like oil or something.  An oil shortage would increase the price of gasoline, increasing the cost of delivering flour, cheese, and pepperoni.  This would increase the cost of producing pizza, therefore decreasing the number of pizzas that can be produced.  Economists call this a supply shock and it causes something called cost push inflation.

Cost Push Inflation is actually a controversial subject between schools of economics, and Wikipedia even includes a section on its criticism.

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The problem that some schools of economic thought have with this idea is that Cost Push Inflation essentially expands the definition of inflation beyond monetary policy.  Since inflation is generally associated with interest rates, the money supply, and purchasing power, the term Cost Push Inflation conflates monetary policy and simple microeconomics.

The critics of the term Cost Push Inflation argue that natural disasters and other events that affect the price of goods should not be considered inflationary, since inflation is a term for monetary policy and affects consumers’ purchasing power, not just the price.

In other words, calling supply shortages “inflation” confuses the term.  Inflation is something that is willfully created by controllers of the money supply (usually the Fed lowering interest rates or the practice of Quantitative Easing), as opposed to something that is caused by nature (Crash Course cites disease and drought as a potential ca